Exhibit 13

Dear:
Shareholders, Friends, and Staff

2007 was a very interesting and challenging year in the financial
services industry. The industry has been burdened by pressure from the widely
talked about and unprecedented decline of the nations residential real estate
market, a liquidity driven credit crisis and a yield curve that remained flat.
As you may know, Pacific State Bank is serving areas that were some of the
hardest hit by the economic problems in 2007. At times, Modesto and Stockton
traded places as the foreclosure capital of our nation. Stock values of many
publicly traded financial institutions have been affected by shrinking net
interest margins and the residential real estate problems which have resulted
in the growth of poor asset quality conditions in the nations top financial
institutions. These negative trends also affected PSBC with our stock price
declining by $9.17 or over 42% since December 31, 2006.

The Companys management was faced with new concerns in 2007 that hurt
the Companys growth and profitability. Some of the issues addressed in 2007
were, competition for deposits from the large national banks and financial
institutions, competition for deposits from online banks, and continued
penetration of brokerage firms into traditional banking products. Large
national companies experienced heavy liquidity demand during the later half of
2007; forcing PSB to pay higher rates on interest bearing deposits in order to
compete. The coupling of higher interest expense and declining assets yields
due to the Federal Reserves Banks drop in the Federal Funds Rate in the fourth
quarter of 2007 lowered the Banks net interest margin. In addition, a complete
credit evaluation of the banks loan portfolio prepared by the banks Chief
Credit Officer, Gary Stewart, resulted in the decision to tighten underwriting
standards and increase the allowance for loan loss reserve. As part of the
tighter underwriting standards, interest rate floors were embedded in all new
or renewed loans. These tactical decisions will result in the Bank maintaining
credit and collateral quality in a deteriorating economic environment, and will
mitigate the Banks exposure to interest earning assets repricing downward more
rapidly than interest bearing liabilities. The resulting benefits are expected
to be recognized for months to come.

Even with the negative financial news buzzing about the financial
services industry, positive news was plentiful within the Company. In 2007
Pacific State Bank was rated in the top 10 highest performing community banks
in the nation by USBanker. On a state and local level, Pacific State Bank was
named bank of the year by the Stockton-Tracy SBA CDC and Ms Laura Maffei was
named by the agency as their banker of the year. In addition, Pacific State
Bank was named bank of the year by United States Department of
Agriculture-Rural Development California, funded the Pflug Industrial
project in Lathrop, California and received the Sandler ONeills 2007 Sm-All
Star Award. In September of 2007 the long awaited grand opening of the Hayward
full service branch was held with an evening reception introducing Pacific
State Bank to the Alameda County community. Finally Pacific State Bancorp and
Pacific State Bank completed our 16th consecutive year of asset
growth.

The company closed the 2007 year at $430,000,000 in total assets and
$4,500,000 in net profit. The Company earned a return on equity of 14.22% and a
return on assets of 1.13%.

|                                                |                                         
|----------------------------------------------- | ----------------------------------------
|Growing in
 the community                       |                                         
|-s- Harold Hand                                 | -s- Steven A. Rosso                     
|Harold Hand
 Chairman of the Board of Directors | Steven A.
 Rosso
 President and C. E. O.

1

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SELECTED FINANCIAL DATA

The information set forth below should be read in conjunction with
Managements Discussion and Analysis of Financial Condition and Results of
Operation and the Companys audited consolidated financial statements and
notes thereto, included elsewhere in this report.

|                                                |  |                         |           |      |   |           |   |      |           |      |   |           |   |   |           |  
|----------------------------------------------- |  | ----------------------- | --------- | ---- | - | --------- | - | ---- | --------- | ---- | - | --------- | - | - | --------- | -
|(Dollars in
 thousands, except per share data)  |  | Year Ended December 31, |          
|                                                |  |                         |          
|                                                |  | 2007                    |           | 2006 |   | 2005      |   | 2004 |           | 2003 |  
|                                                |  |                         |           |      |   |           |   |      |           |      |   |           |   |   |           |  
|Statements of Income:                           |  |                         |           |      |   |           |   |      |           |      |   |           |   |   |           |  
|Total
 Interest Income                          |  | $                       | 31,242    |      | $ | 26,495    |   | $    | 18,782    |      | $ | 13,509    |   | $ | 11,117    |  
|Net Interest
 Income                            |  |                         | 17,400    |      |   | 17,307    |   |      | 13,536    |      |   | 10,451    |   |   | 8,356     |  
|Provision
 for Loan Losses                      |  |                         | 1,425     |      |   | 360       |   |      | 35        |      |   | 504       |   |   | 536       |  
|Total
 Non-interest Income                      |  |                         | 2,465     |      |   | 2,583     |   |      | 2,481     |      |   | 2,525     |   |   | 1,978     |  
|Total
 Non-interest Expenses                    |  |                         | 10,997    |      |   | 10,360    |   |      | 9,100     |      |   | 7,429     |   |   | 6,498     |  
|Provision
 for Income Taxes                     |  |                         | 2,894     |      |   | 3,627     |   |      | 2,596     |      |   | 1,874     |   |   | 1,247     |  
|Net Income                                      |  |                         | 4,549     |      |   | 5,543     |   |      | 4,286     |      |   | 3,169     |   |   | 2,053     |  
|                                                |  |                         |           |      |   |           |   |      |           |      |   |           |   |   |           |  
|Balance Sheets:                                 |  |                         |           |      |   |           |   |      |           |      |   |           |   |   |           |  
|Total Assets                                    |  |                         | 431,074   |      |   | 386,752   |   |      | 309,611   |      |   | 254,361   |   |   | 200,924   |  
|Total
 Investments                              |  |                         | 41,352    |      |   | 23,107    |   |      | 28,539    |      |   | 23,582    |   |   | 15,512    |  
|Total Loans,
 net                               |  |                         | 308,458   |      |   | 287,318   |   |      | 241,556   |      |   | 199,535   |   |   | 157,138   |  
|Allowance
 for Loan Losses (ALL)                |  |                         | 3,948     |      |   | 2,478     |   |      | 2,356     |      |   | 2,214     |   |   | 1,653     |  
|Total
 Deposits                                 |  |                         | 341,821   |      |   | 340,996   |   |      | 273,074   |      |   | 223,761   |   |   | 176,292   |  
|Subordinated
 Debentures                        |  |                         | 8,764     |      |   | 8,764     |   |      | 8,764     |      |   | 8,764     |   |   | 5,155     |  
|Shareholders
 Equity                           |  |                         | 34,036    |      |   | 29,059    |   |      | 21,373    |      |   | 16,830    |   |   | 13,459    |  
|                                                |  |                         |           |      |   |           |   |      |           |      |   |           |   |   |           |  
|Performance Ratios:                             |  |                         |           |      |   |           |   |      |           |      |   |           |   |   |           |  
|Return on
 Average Assets                       |  |                         | 1.13      | %    |   | 1.67      | % |      | 1.53      | %    |   | 1.37      | % |   | 1.07      | %
|Return on
 Average Equity                       |  |                         | 14.22     | %    |   | 22.91     | % |      | 22.98     | %    |   | 21.64     | % |   | 16.86     | %
|Average
 Equity to Average Assets               |  |                         | 7.95      | %    |   | 7.30      | % |      | 6.65      | %    |   | 6.34      | % |   | 6.36      | %
|Tier 1
 Risk-Based Capital                      |  |                         | 11.40     | %    |   | 10.65     | % |      | 10.44     | %    |   | 10.10     | % |   | 10.10     | %
|Total
 Risk-Based Capital                       |  |                         | 12.60     | %    |   | 11.83     | % |      | 11.88     | %    |   | 12.60     | % |   | 11.60     | %
|Net Interest
 Margin                            |  |                         | 4.79      | %    |   | 5.76      | % |      | 5.41      | %    |   | 5.14      | % |   | 4.85      | %
|Average Earning Assets to Average Total
 Assets |  |                         | 90.31     | %    |   | 93.33     | % |      | 89.22     | %    |   | 88.18     | % |   | 89.85     | %
|Nonperforming
 Assets to Total Assets           |  |                         | 0.10      | %    |   |          |   |      |          |      |   |          |   |   |          |  
|ALL to Total
 Loans                             |  |                         | 1.26      | %    |   | 0.86      | % |      | 0.98      | %    |   | 1.10      | % |   | 1.05      | %
|Nonperforming
 Loans to ALL                     |  |                         | 10.94     | %    |   |          |   |      |          |      |   |          |   |   |          |  
|                                                |  |                         |           |      |   |           |   |      |           |      |   |           |   |   |           |  
|Share Data:                                     |  |                         |           |      |   |           |   |      |           |      |   |           |   |   |           |  
|Common
 Shares Outstanding                      |  |                         | 3,703,207 |      |   | 3,661,477 |   |      | 3,512,622 |      |   | 3,448,042 |   |   | 3,377,656 |  
|Book Value
 Per Share                           |  | $                       | 9.19      |      | $ | 7.94      |   | $    | 6.08      |      | $ | 4.88      |   | $ | 3.99      |  
|Basic
 Earnings Per Share                       |  | $                       | 1.23      |      | $ | 1.57      |   | $    | 1.23      |      | $ | 0.92      |   | $ | 0.61      |  
|Diluted
 Earnings Per Share                     |  | $                       | 1.14      |      | $ | 1.41      |   | $    | 1.10      |      | $ | 0.84      |   | $ | 0.59      |  

2

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(PERRY-SMITH LLP LOGO)

One Embarcadero Center, Suite 1330
San Francisco, CA 94111
www. perrysmith. com
415.576.1100

REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM

The Shareholders and Board of Directors
Pacific State Bancorp and Subsidiary

We have
audited the accompanying consolidated balance sheet of Pacific State Bancorp
and subsidiary as of December 31, 2007 and 2006 and the related
consolidated statements of income, changes in shareholders equity,
comprehensive income and cash flows for each of the years in the three-year
period ended December 31, 2007. These consolidated financial statements are the
responsibility of the Companys management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our
opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Pacific State Bancorp and subsidiary as of December 31, 2007 and 2006, and the
consolidated results of their operations and their cash flows for each of the
years in the three-year period ended December 31, 2007, in conformity with
accounting principles generally accepted in the United States of America.

-s- Perry-Smith LLP

March 28, 2008

SACRAMENIO ^
SAN FRANCISCO

3

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PACIFIC STATE BANCORP AND SUBSIDIARY

CONSOLIDATED BALANCE SHEET

December 31, 2007 and 2006 
(In thousands, except share amounts)

|                                                                                                                                          |  |      |         |      |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | ---- | - | ------- | -
|                                                                                                                                          |  | 2007 |         | 2006 |  
|                                                                                                                                          |  |      |         |      |  
|ASSETS                                                                                                                                    |  |      |         |      |   |         |  
|Cash and due from banks                                                                                                                   |  | $    | 13,794  |      | $ | 18,985  |  
|Federal funds sold                                                                                                                        |  |      | 31,880  |      |   | 31,630  |  
|                                                                                                                                          |  |      |         |      |   |         |  
|Total cash and cash equivalents                                                                                                           |  |      | 45,674  |      |   | 50,615  |  
|Interest-bearing deposits in other banks                                                                                                  |  |      | 3,000   |      |   |        |  
|Investment securities (Notes 3 and 7)                                                                                                     |  |      | 41,352  |      |   | 23,107  |  
|Loans,
 less allowance for loan losses of $3,948 in 2007 and $2,478 in 2006 (Notes 4,
 7, 10 and 13)                                      |  |      | 308,458 |      |   | 287,318 |  
|Premises and equipment, net (Note 5)                                                                                                      |  |      | 14,269  |      |   | 11,957  |  
|Company owned life insurance (Note 14)                                                                                                    |  |      | 8,025   |      |   | 6,079   |  
|Accrued interest receivable and other assets (Note 9)                                                                                     |  |      | 10,296  |      |   | 7,676   |  
|                                                                                                                                          |  |      |         |      |   |         |  
|Total assets                                                                                                                              |  | $    | 431,074 |      | $ | 386,752 |  
|                                                                                                                                          |  |      |         |      |   |         |  
|LIABILITIES ANDSHAREHOLDERS EQUITY                                                                                                       |  |      |         |      |   |         |  
|Deposits:                                                                                                                                 |  |      |         |      |   |         |  
|Non-interest bearing                                                                                                                      |  | $    | 67,071  |      | $ | 73,197  |  
|Interest bearing (Note 6)                                                                                                                 |  |      | 274,750 |      |   | 267,799 |  
|                                                                                                                                          |  |      |         |      |   |         |  
|Total deposits                                                                                                                            |  |      | 341,821 |      |   | 340,996 |  
|Other borrowings (Note 7)                                                                                                                 |  |      | 40,000  |      |   | 4,900   |  
|Subordinated debentures (Note 8)                                                                                                          |  |      | 8,764   |      |   | 8,764   |  
|Accrued interest payable and other
liabilities                                                                                            |  |      | 6,453   |      |   | 3,033   |  
|                                                                                                                                          |  |      |         |      |   |         |  
|Total liabilities                                                                                                                         |  |      | 397,038 |      |   | 357,693 |  
|                                                                                                                                          |  |      |         |      |   |         |  
|Commitments and contingencies (Note 10)                                                                                                   |  |      |         |      |   |         |  
|Shareholders equity (Note 11):                                                                                                           |  |      |         |      |   |         |  
|Preferred stock - 2,000,000 shares authorized; none
issued or
 outstanding                                                                |  |      |        |      |   |        |  
|Common stock - no par value; 24,000,000 shares
authorized; issued and
 outstanding 3,703,207 shares in 2007 and 3,661,477 shares in 2006 |  |      | 10,418  |      |   | 9,651   |  
|Retained earnings                                                                                                                         |  |      | 24,004  |      |   | 19,455  |  
|Accumulated other comprehensive loss, net of taxes
(Notes 3 and 15)                                                                       |  |      | (386    | )    |   | (47     | )
|                                                                                                                                          |  |      |         |      |   |         |  
|Total shareholders equity                                                                                                                |  |      | 34,036  |      |   | 29,059  |  
|                                                                                                                                          |  |      |         |      |   |         |  
|Total liabilities and shareholders
equity                                                                                                |  | $    | 431,074 |      | $ | 386,752 |  
|                                                                                                                                          |  |      |         |      |   |         |  

The accompanying notes are an integral 
part of these consolidated financial statements

4

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PACIFIC STATE BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENT OF INCOME

For the Years Ended December 31, 2007, 2006 and 2005 
(In thousands, except per share amounts)

|                                                      |  |      |        |      |   |        |  |   |        | 
|----------------------------------------------------- |  | ---- | ------ | ---- | - | ------ |  | - | ------ | 
|                                                      |  | 2007 |        | 2006 |   | 2005   | 
|                                                      |  |      |        |      |   |        | 
|Interest
 income:                                     |  |      |        |      |   |        |  |   |        | 
|Interest and fees on loans                            |  | $    | 27,902 |      | $ | 24,901 |  | $ | 17,565 | 
|Interest on Federal funds
 sold                       |  |      | 1,285  |      |   | 273    |  |   | 354    | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|Interest
 and dividends on investment securities:     |  |      |        |      |   |        |  |   |        | 
|Taxable                                               |  |      | 1,843  |      |   | 1,093  |  |   | 510    | 
|Exempt from Federal income
 taxes                     |  |      | 134    |      |   | 158    |  |   | 151    | 
|Dividends                                             |  |      | 78     |      |   | 70     |  |   | 202    | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|Total interest income                                 |  |      | 31,242 |      |   | 26,495 |  |   | 18,782 | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|Interest
 expense:                                    |  |      |        |      |   |        |  |   |        | 
|Interest on deposits (Note
 6)                        |  |      | 12,844 |      |   | 8,102  |  |   | 4,610  | 
|Interest on borrowings
 (Note 7)                      |  |      | 296    |      |   | 376    |  |   | 109    | 
|Interest on subordinated
 debentures (Note 8)         |  |      | 702    |      |   | 710    |  |   | 527    | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|Total interest expense                                |  |      | 13,842 |      |   | 9,188  |  |   | 5,246  | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|Net interest income before
 provision for loan losses |  |      | 17,400 |      |   | 17,307 |  |   | 13,536 | 
|Provision for loan losses
 (Note 4)                   |  |      | 1,425  |      |   | 360    |  |   | 35     | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|Net interest income after
 provision for loan losses  |  |      | 15,975 |      |   | 16,947 |  |   | 13,501 | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|Non-interest
 income:                                 |  |      |        |      |   |        |  |   |        | 
|Service charges                                       |  |      | 889    |      |   | 864    |  |   | 758    | 
|Gain on sale of loans                                 |  |      | 150    |      |   | 294    |  |   | 809    | 
|Other income                                          |  |      | 1,426  |      |   | 1,425  |  |   | 914    | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|Total non-interest income                             |  |      | 2,465  |      |   | 2,583  |  |   | 2,481  | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|Non-interest
 expenses:                               |  |      |        |      |   |        |  |   |        | 
|Salaries and employee
 benefits (Notes 4 and 14)      |  |      | 5,336  |      |   | 5,479  |  |   | 4,742  | 
|Occupancy (Notes 5 and 10)                            |  |      | 1,180  |      |   | 980    |  |   | 782    | 
|Furniture and equipment
 (Notes 5 and 10)             |  |      | 708    |      |   | 672    |  |   | 664    | 
|Other expenses (Note 12)                              |  |      | 3,773  |      |   | 3,229  |  |   | 2,912  | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|Total non-interest
 expenses                          |  |      | 10,997 |      |   | 10,360 |  |   | 9,100  | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|Income before provision
 for income taxes             |  |      | 7,443  |      |   | 9,170  |  |   | 6,882  | 
|Provision for income taxes
 (Note 9)                  |  |      | 2,894  |      |   | 3,627  |  |   | 2,596  | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|Net income                                            |  | $    | 4,549  |      | $ | 5,543  |  | $ | 4,286  | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|Basic earnings per share
 (Note 11)                   |  | $    | 1.23   |      | $ | 1.57   |  | $ | 1.23   | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|                                                      |  |      |        |      |   |        |  |   |        | 
|Diluted earnings per share
 (Note 11)                 |  | $    | 1.14   |      | $ | 1.41   |  | $ | 1.10   | 
|                                                      |  |      |        |      |   |        |  |   |        | 

The
accompanying notes are an integral 
part of these consolidated financial statements

5

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PACIFIC STATE BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN
SHAREHOLDERS EQUITY

For the Years Ended December 31, 2007, 2006 and 2005 
(In thousands, except share and per share amounts)

|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|------------------------------------------------------------------------------------------------ |  | ------------ | --------- | ------ | - | ------------------ | - | - | -------------------------- |  | -------------------------------------------------------------------- | ---- | - | - | ------ | -
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  | Accumulated
 Other
 Compre-
 hensive
 (Loss)
 Income (Net
 of Taxes) |      |   |   |       
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |  
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |  
|                                                                                                 |  | Common Stock |           |        |   |                    |   |   |                            | 
|                                                                                                 |  |              |           |        |   |                    |   |   |                            | 
|                                                                                                 |  | Shares       |           | Amount |   | Retained
 Earnings |   |   | TotalShareholders
 Equity | 
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                     
|Balance, January 1, 2005                                                                         |  |              | 3,448,042 |        | $ | 7,159              |   | $ | 9,626                      |  | $                                                                    | 45   |   | $ | 16,830 |  
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|Net income                                                                                       |  |              |           |        |   |                    |   |   | 4,286                      |  |                                                                      |      |   |   | 4,286  |  
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|Net change in unrealized gains (losses) on available-for-sale
 investment securities, net of tax |  |              |           |        |   |                    |   |   |                            |  |                                                                      | (140 | ) |   | (140   | )
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|Stock options exercised and related tax benefit (Note 11)                                        |  |              | 65,760    |        |   | 409                |   |   |                            |  |                                                                      |      |   |   | 409    |  
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|Repurchase and retirement of common stock                                                        |  |              | (1,180    | )      |   | (12                | ) |   |                            |  |                                                                      |      |   |   | (12    | )
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|Balance, December 31, 2005                                                                       |  |              | 3,512,622 |        |   | 7,556              |   |   | 13,912                     |  |                                                                      | (95  | ) |   | 21,373 |  
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|Net income                                                                                       |  |              |           |        |   |                    |   |   | 5,543                      |  |                                                                      |      |   |   | 5,543  |  
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|Net change in unrealized gains (losses) on available-for-sale
 investment securities, net of tax |  |              |           |        |   |                    |   |   |                            |  |                                                                      | 48   |   |   | 48     |  
|Stock-based compensation expense                                                                 |  |              |           |        |   | 229                |   |   |                            |  |                                                                      |      |   |   | 229    |  
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|Stock options exercised and related tax benefit (Note 11)                                        |  |              | 135,421   |        |   | 1,616              |   |   |                            |  |                                                                      |      |   |   | 1,616  |  
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|Proceeds from issuance of stock                                                                  |  |              | 13,434    |        |   | 250                |   |   |                            |  |                                                                      |      |   |   | 250    |  
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|Balance, December 31, 2006                                                                       |  |              | 3,661,477 |        |   | 9,651              |   |   | 19,455                     |  |                                                                      | (47  | ) |   | 29,059 |  
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|Net income                                                                                       |  |              |           |        |   |                    |   |   | 4,549                      |  |                                                                      |      |   |   | 4,549  |  
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|Net change in unrealized gains (losses) on available-for-sale
 investment securities, net of tax |  |              |           |        |   |                    |   |   |                            |  |                                                                      | (339 | ) |   | (339   | )
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|Stock-based compensation expense                                                                 |  |              |           |        |   | 309                |   |   |                            |  |                                                                      |      |   |   | 309    |  
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|Stock options exercised and related tax benefit (Note 11)                                        |  |              | 41,730    |        |   | 458                |   |   |                            |  |                                                                      |      |   |   | 458    |  
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  
|Balance, December 31, 2007                                                                       |  |              | 3,703,207 |        | $ | 10,418             |   | $ | 24,004                     |  | $                                                                    | (386 | ) | $ | 34,036 |  
|                                                                                                 |  |              |           |        |   |                    |   |   |                            |  |                                                                      |      |   |   |        |  

The accompanying notes are an integral 
part of these consolidated financial statements

6

---



PACIFIC STATE BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE
INCOME

For the Years Ended December 31, 2007, 2006 and 2005
(In thousands)

|                                                                       |  |      |       |      |   |       |  |   |       |  
|---------------------------------------------------------------------- |  | ---- | ----- | ---- | - | ----- |  | - | ----- | -
|                                                                       |  | 2007 |       | 2006 |   | 2005  | 
|                                                                       |  |      |       |      |   |       | 
|                                                                      
|Net income                                                             |  | $    | 4,549 |      | $ | 5,543 |  | $ | 4,286 |  
|                                                                       |  |      |       |      |   |       |  |   |       |  
|Other comprehensive income
 (loss):                                    |  |      |       |      |   |       |  |   |       |  
|Unrealized holding
 (losses) gains arising during the year, net of tax |  |      | (339  | )    |   | 48    |  |   | (140  | )
|                                                                       |  |      |       |      |   |       |  |   |       |  
|Total comprehensive income                                             |  | $    | 4,210 |      | $ | 5,591 |  | $ | 4,286 |  
|                                                                       |  |      |       |      |   |       |  |   |       |  

The accompanying notes are an integral 
part of these consolidated financial statements

7

---



PACIFIC STATE BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENT OF CASH FLOWS

For the Years Ended December 31, 2007, 2006 and 2005
(In thousands)

|                                                                                                              |  |      |         |      |   |         |   |   |         |  
|------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | ---- | - | ------- | - | - | ------- | -
|                                                                                                              |  | 2007 |         | 2006 |   | 2005    |  
|                                                                                                              |  |      |         |      |   |         |  
|                                                                                                              |  |      |         |      |   |         |   |   |         |  
|Cash flows from operating activities:                                                                         |  |      |         |      |   |         |   |   |         |  
|Net income                                                                                                    |  | $    | 4,549   |      | $ | 5,543   |   | $ | 4,286   |  
|Adjustments to reconcile net income to net cash
provided by operating
  activities:                           |  |      |         |      |   |         |   |   |         |  
|Provision for loan losses                                                                                     |  |      | 1,425   |      |   | 360     |   |   | 35      |  
|Net (increase) decrease in deferred loan
origination costs                                                    |  |      | (168    | )    |   | 173     |   |   | (14     | )
|Depreciation, amortization and accretion,
net                                                                 |  |      | 93      |      |   | 404     |   |   | 600     |  
|Gain on sale of loans, net                                                                                    |  |      | (150    | )    |   | (294    | ) |   | (809    | )
|Loss on sale of premises or equipment                                                                         |  |      | 57      |      |   |        |   |   |        |  
|Stock-based compensation expense                                                                              |  |      | 309     |      |   | 229     |   |   |        |  
|Tax benefit from exercise of options                                                                          |  |      | (223    | )    |   | (736    | ) |   | (79     | )
|Increase in Company owned life insurance,
net                                                                 |  |      | (246    | )    |   | (208    | ) |   | (165    | )
|Increase in accrued interest receivable and other
assets                                                      |  |      | (651    | )    |   | (392    | ) |   | (1,094  | )
|Increase in accrued interest payable and other
liabilities                                                    |  |      | 3,420   |      |   | 418     |   |   | 1,394   |  
|Provision (benefit) for deferred income
taxes                                                                 |  |      | (755    | )    |   | 12      |   |   | (131    | )
|                                                                                                              |  |      |         |      |   |         |   |   |         |  
|                                                                                                              |  |      |         |      |   |         |   |   |         |  
|Net cash provided by operating
activities                                                                     |  |      | 7,660   |      |   | 5,509   |   |   | 4,023   |  
|                                                                                                              |  |      |         |      |   |         |   |   |         |  
|                                                                                                              |  |      |         |      |   |         |   |   |         |  
|Cash flows from investing activities:                                                                         |  |      |         |      |   |         |   |   |         |  
|Net (increase) decrease in interest-bearing
deposits in other banks                                           |  |      | (3,000  | )    |   |        |   |   | 6,100   |  
|Purchases of available-for-sale investment
securities                                                         |  |      | (53,022 | )    |   | (11,257 | ) |   | (13,992 | )
|Proceeds from matured and called available-for-sale
investment
  securities                                   |  |      | 33,805  |      |   | 16,364  |   |   | 1,800   |  
|Proceeds from principal repayments from
available-for-sale
  government-guaranteed mortgage-backed securities |  |      | 1,068   |      |   | 696     |   |   | 979     |  
|investment securities                                                                                         |  |      |        |      |   | 26      |   |   |        |  
|Proceeds from principal repayments from
held-to-maturity government-guarantee
  mortgage-backed securities    |  |      | 5       |      |   | 23      |   |   | 21      |  
|Purchase of FRB and FHLB stock                                                                                |  |      | (831    | )    |   | (180    | ) |   |        |  
|Net increase in loans                                                                                         |  |      | (22,247 | )    |   | (45,786 | ) |   | (41,233 | )
|Purchases of premises and equipment                                                                           |  |      | (3,072  | )    |   | (3,128  | ) |   | (396    | )
|Purchase of Company owned life insurance                                                                      |  |      | (1,700  | )    |   | (1,460  | ) |   |         |  
|                                                                                                              |  |      |         |      |   |         |   |   |         |  
|                                                                                                              |  |      |         |      |   |         |   |   |         |  
|Net cash used in investing activities                                                                         |  |      | (48,984 | )    |   | (44,702 | ) |   | (46,721 | )
|                                                                                                              |  |      |         |      |   |         |   |   |         |  

8

---



PACIFIC STATE BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENT OF CASH FLOWS

For the Years Ended December 31, 2007, 2006 and 2005
(In thousands)

|                                                                                  |  |      |         |      |   |         |   |   |        |  
|--------------------------------------------------------------------------------- |  | ---- | ------- | ---- | - | ------- | - | - | ------ | -
|                                                                                  |  | 2007 |         | 2006 |   | 2005    |  
|                                                                                  |  |      |         |      |   |         |  
|                                                                                  |  |      |         |      |   |         |   |   |        |  
|Cash flows from financing activities:                                             |  |      |         |      |   |         |   |   |        |  
|Net (decrease) increase in demand, interest-bearing
and savings
  deposits        |  | $    | (21,893 | )    | $ | (12,262 | ) | $ | 26,861 |  
|Net increase in time deposits                                                     |  |      | 22,718  |      |   | 81,184  |   |   | 22,452 |  
|Proceeds from exercise of stock options                                           |  |      | 235     |      |   | 880     |   |   | 330    |  
|Excess tax benefit from exercise of stock
options                                 |  |      | 223     |      |   | 736     |   |   | 79     |  
|Share repurchase and retirement                                                   |  |      |         |      |   |        |   |   | (12    | )
|Proceeds from the issuance of mandatorily
redeemable trust preferred
  securities |  |      |         |      |   |         |   |   |       |  
|Proceeds from stock issuance                                                      |  |      |         |      |   | 250     |   |   |       |  
|Net increase in other borrowings                                                  |  |      | 35,100  |      |   | 900     |   |   |       |  
|                                                                                  |  |      |         |      |   |         |   |   |        |  
|                                                                                  |  |      |         |      |   |         |   |   |        |  
|Net cash provided by financing
activities                                         |  |      | 36,383  |      |   | 70,688  |   |   | 49,710 |  
|                                                                                  |  |      |         |      |   |         |   |   |        |  
|                                                                                  |  |      |         |      |   |         |   |   |        |  
|Increase (Decrease) in cash and cash
equivalents                                  |  |      | (4,941  | )    |   | 31,495  |   |   | 7,012  |  
|                                                                                  |  |      |         |      |   |         |   |   |        |  
|Cash and cash equivalents at beginning of year                                    |  |      | 50,615  |      |   | 19,120  |   |   | 12,108 |  
|                                                                                  |  |      |         |      |   |         |   |   |        |  
|                                                                                  |  |      |         |      |   |         |   |   |        |  
|Cash and cash equivalents at end of year                                          |  | $    | 45,674  |      | $ | 50,615  |   | $ | 19,120 |  
|                                                                                  |  |      |         |      |   |         |   |   |        |  
|                                                                                  |  |      |         |      |   |         |   |   |        |  
|Supplemental disclosure of cash flow information:                                 |  |      |         |      |   |         |   |   |        |  
|                                                                                  |  |      |         |      |   |         |   |   |        |  
|Cash paid during the year for:                                                    |  |      |         |      |   |         |   |   |        |  
|Interest expense                                                                  |  | $    | 13,048  |      | $ | 10,475  |   | $ | 4,773  |  
|Income taxes                                                                      |  | $    | 2,500   |      | $ | 3,805   |   | $ | 2,081  |  
|                                                                                  |  |      |         |      |   |         |   |   |        |  
|Non-cash investing activities:                                                    |  |      |         |      |   |         |   |   |        |  
|Net change in unrealized loss on available-for-sale
investment
  securities       |  | $    | (565    | )    | $ | 78      |   | $ | (233   | )

The accompanying notes are an integral
part of these consolidated financial statements.

9

---



PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|                            
|----------------------------
|NOTE 1. NATURE OF OPERATIONS
|                            

On June 24,
2002, Pacific State Bancorp (Bancorp) commenced operations as a bank holding
company by acquiring all of the outstanding shares of Pacific State Bank
(Bank) in a one bank holding company reorganization. This corporate structure
gives Bancorp and the Bank greater flexibility in terms of operation,
expansion, and diversification.

Pacific
State Bancorps subsidiaries include the Bank, Pacific State Statutory Trust II
and Pacific State Statutory Trust III. Pacific
State Statutory Trust II and Pacific State Statutory Trust III are
unconsolidated Delaware statutory business trusts formed in March 2004 and June
2007, respectively, for the exclusive purpose of issuing and selling trust
preferred securities and holding subordinated debentures issued by Bancorp. The proceeds
from the issuance of subordinated debentures in 2004 were utilized by Bancorp
to provide capital to the Bank and for general corporate purposes. The proceeds
from the issuance of subordinated debenture in 2007 were utilized to retire
subordinated debentures issued in 2002.

The Bank commenced operations in 1987
and is a California state-chartered member bank of the Federal Reserve System. The
Bank operates nine branches in California, including two branches in Stockton
and branches in Modesto, Groveland, Arnold, Angels Camp, Tracy, Lodi and
Hayward. The Banks primary source of revenue is providing loans to customers
who are predominately small and middle-market businesses and individuals.

|                                                  
|--------------------------------------------------
|NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
|                                                  

The accounting
and reporting policies of Pacific State Bancorp and its subsidiary
(collectively, the Company) conform with accounting principles generally
accepted in the United States and prevailing practice within the banking
industry. The more significant of these policies applied in the preparation of
the accompanying consolidated financial statements are discussed below.

PRINCIPLES OF CONSOLIDATION

The
accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiary, Pacific State Bank. Significant
intercompany transactions and balances have been eliminated in consolidation.
For financial reporting purposes, the Companys investment in Pacific State
Statutory Trusts I, II and III (Trusts) are accounted for under the equity
method and are included in accrued interest receivable and other assets in the
consolidated balance sheet. The subordinated debentures issued and guaranteed
by the Company and held by the Trusts are included as subordinated debentures
in the consolidated balance sheet.

SEGMENT INFORMATION

Management has
determined that because all of the banking products and services offered by the
Company are available in each branch of the Bank, all branches are located
within the same economic environment and management does not allocate resources
based on the performance of different lending or transaction activities, it is
appropriate to aggregate the Bank branches and report them as a single
operating segment. No customer accounts for more than 10 percent of revenues
for the Company or the Bank.

USE OF ESTIMATES

The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions. These estimates and assumptions affect the reported
amounts of assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from these estimates.

RECLASSIFICATIONS

Certain
reclassifications have been made to prior years balances to conform to
classifications used in 2007.

CASH AND CASH EQUIVALENTS

For the purpose of the
statement of cash flows, cash, due from banks and Federal funds sold are
considered to be cash equivalents. Generally, Federal funds are sold for
one-day periods.

10

---



PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)

INVESTMENT SECURITIES

Investment
securities are classified into the following categories:

| |                                                                                                                                                                                                                                       
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |           Available-for-sale
 securities, reported at fair value, with unrealized gains and losses excluded
 from earnings and reported, net of taxes, as accumulated other comprehensive
 income (loss) within shareholders equity.
| |                                                                                                                                                                                                                                       
| |           Held-to-maturity
 securities, which management has the positive intent and ability to hold to
 maturity, reported at amortized cost, adjusted for the accretion of discounts
 and amortization of premiums.                

Management
determines the appropriate classification of its investments at the time of
purchase and may only change the classification in certain limited
circumstances. The Company did not have any investments classified as trading
at December 31, 2007 or 2006. All transfers between categories are accounted
for at fair value. There were no transfers between categories in 2007 or 2006.

Gains
or losses on the sale of investment securities are computed on the specific
identification method. Interest earned on investment securities is reported in
interest income, net of applicable adjustments for accretion of discounts and
amortization of premiums.

Investment
securities are evaluated for impairment on at least a quarterly basis and more
frequently when economic or market conditions warrant such an evaluation to
determine whether a decline in their value is other than temporary. Management
utilizes criteria such as the magnitude and duration of the decline and the
intent and ability of the Company to retain its investment in the securities
for a period of time sufficient to allow for an anticipated recovery in fair
value, in addition to the reasons underlying the decline, to determine whether
the loss in value is other than temporary. The term other than temporary is
not intended to indicate that the decline is permanent, but indicates that the
prospects for a near-term recovery of value is not necessarily favorable, or
that there is a lack of evidence to support a realizable value equal to or
greater than the carrying value of the investment. Once a decline in value is
determined to be other than temporary, the value of the security is reduced and
a corresponding charge to earnings is recognized.

As
a member of the Federal Reserve System, the Federal Home Loan Bank System and
the Farmer Mac Home Administration System, the Bank is required to maintain an
investment in restricted capital stock of each system. These investments are
carried at cost and are redeemable at par and are included in accrued interest
receivable and other assets in the consolidated balance sheet.

LOANS

Loans are
stated at principal balances outstanding. Interest is accrued daily based upon
outstanding loan balances. However, when, in the opinion of management, loans
are considered to be impaired and the future collectability of interest and
principal is in serious doubt, loans are placed on nonaccrual status and the
accrual of interest income is suspended. Any interest accrued but unpaid is
charged against income. Payments received are applied to reduce principal to
the extent necessary to ensure collection. Subsequent payments on these loans,
or payments received on nonaccrual loans for which the ultimate collectability
of principal is not in doubt, are applied first to earned but unpaid interest
and then to principal.

An
impaired loan is measured based on the present value of expected future cash
flows discounted at the loans effective interest rate or, as a practical
matter, at the loans observable market price or the fair value of collateral
if the loan is collateral dependent. A loan is considered impaired when, based
on current information and events, it is probable that the Company will be
unable to collect all amounts due (including both principal and interest) in
accordance with the contractual terms of the loan agreement. Interest income on
impaired loans, if appropriate, is recognized on a cash basis.

Loan
origination fees, commitment fees, direct loan origination costs and purchase
premiums and discounts on loans are deferred and recognized as an adjustment of
yield, and amortized to interest income over the contractual term of the loan.
The unamortized balance of deferred fees and costs is reported as a component
of net loans.

The
Company may purchase loans or acquire loans through a business combination for
which differences exist between the contractual cash flows and the cash flows
expected to be collected due, at least in part, to credit quality. When the
Company acquires such loans, the yield that may be accreted (accretable yield)
is limited to the excess of the Companys estimate of undiscounted cash flows
expected to be collected over the Companys initial investment in the loan. The
excess of contractual cash flows over cash flows expected to be collected may
not be recognized as an adjustment to yield, loss, or a valuation allowance.
Subsequent increases in cash flows expected to be collected generally should be
recognized prospectively through adjustment of the loans yield over its
remaining life. Decreases in cash flows expected to be collected should be recognized
as an impairment. The Company may not carry over or create a valuation
allowance in the initial accounting for loans acquired under these
circumstances. At December 31, 2007 and 2006, there were no such loans being
accounted for under this policy.

11

---



PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)

LOAN SALES AND SERVICING

The Company
accounts for the transfer and servicing of financial assets based on the
financial and servicing assets it controls and liabilities it has incurred,
derecognizes financial assets when control has been surrendered and
derecognizes liabilities when extinguished.

Government
Guaranteed Loans

Included in
the loan portfolio are loans which are 75% to 90% guaranteed by the Small Business
Administration (SBA), Farmer Mac and USDA Business and Industry. The guaranteed
portion of these loans may be sold to a third party, with the Company retaining
the unguaranteed portion. The Company generally receives a premium in excess of
the adjusted carrying value of the loan at the time of sale. The Company may be
required to refund a portion of the sales premium if the borrower defaults or
prepays within ninety days of the settlement date. At December 31, 2007, there
were no premiums subject to these recourse provisions.

The
Companys investment in the loan is allocated between the retained portion of
the loan, the servicing asset (liability) and the sold portion of the loan
based on their relative fair values on the date the loan is sold. The gain on
the sold portion of the loan is recognized as income at the time of sale. The
carrying value of the retained portion of the loan is discounted based on the
estimated value of a comparable non-guaranteed loan. The servicing asset
(liability) is recognized and amortized over the estimated life of the related
loan. Significant future prepayments of these loans will result in the
recognition of additional amortization of related servicing assets
(liabilities).

The
Company serviced government-guaranteed loans for others totaling $47,714,000
and $47,285,000 as of December 31, 2007 and 2006 respectively.

Servicing Rights

Servicing
rights acquired through 1) a purchase or 2) the origination of loans which are
sold with servicing rights retained are recognized as separate assets or
liabilities. Servicing assets or liabilities are recorded at the difference
between the contractual servicing fees and adequate compensation for performing
the servicing, and are subsequently amortized in proportion to and over the
period of the related net servicing income or expense. Servicing assets are
periodically evaluated for impairment. Servicing rights were not significant at
December 31, 2007 and 2006.

ALLOWANCE FOR LOAN LOSSES

The allowance
for loan losses is maintained to provide for losses related to impaired loans
and other losses that can be expected to occur in the normal course of
business. The determination of the allowance is based on estimates made by
management, to include consideration of the character of the loan portfolio,
specifically identified problem loans, potential losses inherent in the
portfolio taken as whole and economic conditions in the Companys service area.

Classified
loans and loans determined to be impaired are individually evaluated by
management for specific risk of loss. In addition, reserve factors are assigned
to currently performing loans based on managements assessment of the following
for each identified loan type: (1) inherent credit risk, (2) historical losses
and, (3) where the Company has not experienced losses, the loss experience of
peer banks. These estimates are particularly susceptible to changes in the
economic environment and market conditions.

The
Banks Loan Committee reviews the adequacy of the allowance for loan losses at
least quarterly, to include consideration of the relative risks in the
portfolio and current economic conditions and other factors. The allowance is
adjusted based on that review if, in the judgment of the Loan Committee and
management, changes are warranted.

This
allowance is established through a provision for loan losses which is charged
to expense. Additions to the allowance are expected to maintain the adequacy of
the total allowance after net charge-offs and loan growth. The allowance for
loan losses at December 31, 2007 and 2006, respectively, reflects managements
estimate of probable losses in the portfolio.

OTHER REAL ESTATE

Other real
estate includes real estate acquired in full or partial settlement of loan
obligations. When property is acquired, any excess of the Companys recorded
investment in the loan balance and accrued interest income over the estimated
fair market value of the property, net of estimated selling costs, is charged
against the allowance for loan losses. A valuation allowance for losses on
other real estate is maintained to provide for temporary declines in value. The
allowance is established through a provision for losses on other real estate
which is included in other expenses. Subsequent gains or losses on sales or
writedowns resulting from permanent impairments are recorded in other income or
expenses as incurred. At December 31, 2007 and 2006, the Company did not have
any other real estate owned.

12

---



PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)

PREMISES AND EQUIPMENT

Premises and
equipment are carried at cost. Depreciation is determined using the
straight-line method over the estimated useful lives of the related assets. The
useful lives of premises are estimated to be twenty to twenty-seven years. The
useful lives of furniture, fixtures and equipment are estimated to be two to
seven years. Leasehold improvements are amortized over the life of the asset or
the life of the related lease, whichever is shorter. When assets are sold or
otherwise disposed of, the cost and related accumulated depreciation and
amortization are removed from the accounts, and any resulting gain or loss is
recognized in income for the period. The cost of maintenance and repairs is
charged to expense as incurred.

The
Company evaluates premises and equipment for financial impairment as events or
changes in circumstances indicate that the carrying amount of such assets may
not be fully recoverable.

GOODWILL AND INTANGIBLE ASSETS

As a result of
the Companys 2002 acquisition of the Stockton branch of California Bank &
Trust, the Company recognized a core deposit intangible asset of $448,000 and
goodwill of $718,000. The valuation of the core deposit intangible was based on
the estimated fair value of deposits acquired and is amortized on a
straight-line basis over a period of ten years. The current balance of the core
deposit intangible of $91,000 is included in accrued interest receivable and other
assets in the consolidated balance sheet. Goodwill is not amortized, but is
measured along with the core deposit intangible for impairment. At December 31,
2007 and 2006, no impairment of the core deposit intangible or goodwill has
been recognized in the Companys consolidated financial statements.

INCOME TAXES

The Company
files its income taxes on a consolidated basis with its subsidiary. The
allocation of income tax expense (benefit) represents each entitys
proportionate share of the consolidated provision for income taxes.

Deferred
tax assets and liabilities are recognized for the tax consequences of temporary
differences between the reported amounts of assets and liabilities and their
tax basis. Deferred tax assets and liabilities are adjusted for the effects of
changes in tax laws and rates on the date of enactment. On the consolidated
balance sheet, net deferred tax assets are included in accrued interest
receivable and other assets.

On
January 1, 2007, the Company adopted Financial Accounting Standards Board
(FASB) Interpretation No. 48, Accounting
for Uncertainty in Income Taxes (FIN 48). FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprises
financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48
prescribes a recognition threshold and measurement standard for the financial
statement recognition and measurement of an income tax position taken or
expected to be taken in a tax return. In addition, FIN 48 provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition.

The
provisions of FIN 48 have been applied to all tax positions of the Company as
of January 1, 2007. Only tax positions that met the more-likely-than-not
recognition threshold on January 1, 2007 were recognized or continue to be
recognized upon adoption. The Company previously recognized income tax
positions based on managements estimate of whether it was reasonably possible
that a liability has been incurred for unrecognized income tax benefits by
applying FASB Statement No. 5, Accounting
for Contingencies. The adoption of FIN 48 did not have a material
impact on the Companys financial position, results of operations or cash
flows.

The
Company recognizes interest accrued and penalties related to unrecognized tax
benefits, if any in tax expense.

EARNINGS PER SHARE

Basic earnings
per share (EPS), which excludes dilution, is computed by dividing income
available to common shareholders by the weighted-average number of common
shares outstanding for the period. Diluted EPS reflects the potential dilution
that could occur if securities or other contracts to issue common stock, such
as stock options, result in the issuance of common stock which shares in the
earnings of the Company. All data with respect to computing earnings per share
is retroactively adjusted to reflect stock splits and dividends and the
treasury stock method is applied to determine the dilutive effect of stock
options in computing diluted EPS.

SHARE-BASED COMPENSATION

At December
31, 2007, the Company had one shareholder approved stock-based compensation
plan which is described more fully in Note 11. Prior to January 1, 2006, the Company
accounted for share-based compensation under the recognition and measurement
provisions of Accounting Principals Board Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees,
and related interpretations, as permitted by Financial Accounting Standards
Board Statement No. 123 (SFAS 123), Accounting
for Stock-Based Compensation and FASB Statement No. 148, Accounting for Stock-Based Compensation - Transition
and Disclosure. For the year ended December 31, 2005, no share-based
employee compensation cost was recognized in the consolidated statement of
income for options granted as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on the
date of grant.

13

---



PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(CONTINUED)

Effective
January 1, 2006, the Company adopted the fair value recognition provisions of
FASB Statement No. 123(R), Share-Based
Payment (SFAS 123(R)), using the modified prospective transition
method. Under that transition method, compensation cost recognized in fiscal
years 2006 and 2007 includes: (a) compensation cost for all share-based
payments vesting during 2006 and 2007 that were granted prior to, but not yet
vested as of January 1, 2006, based on the grant-date fair value estimated in
accordance with the original provisions of SFAS 123, and (b) compensation cost
for all share-based payments vesting during 2006 and 2007 that were granted
subsequent to January 1, 2006, based on the grant-date fair value estimated in
accordance with the provisions of SFAS 123(R). For further information on
grants and vesting please refer to Note 11. The Company applied the alternative
transition method in calculating its pool of excess tax benefits available to
absorb future tax deficiencies as provided by FSP FAS 123(R)-3, Transition Election Related to Accounting for the Tax
Effects of Share-Based Payment Awards.Compensation cost is
recognized net of estimated forfeitures. Results for prior periods have not
been restated.

As
a result of adopting SFAS 123(R), the Company recorded an expense of $309,000
or $239,000 after tax in 2007 and $229,000 or $133,000 after tax in 2006.
Recording the share based compensation expense in accordance with SFAS 123(R)
rather than APB 25 resulted in a reduction in basic and diluted earnings per
share of $0.06 in 2007 and $0.03 in 2006.

Determining Fair
Value

The Company
bases the fair value of the options previously granted on the date of grant
using a Black-Scholes option pricing model that uses assumptions based on
expected option life, the level of expected stock volatility and the risk-free
interest rate. Stock volatility is based on the historical volatility of the
Companys stock. The risk-free rate is based on the U.S. Treasury yield curve
and the expected term of the options. The expected term of the options
represents the period that the Companys share-based awards are expected to be
outstanding based on the terms of the optionees employment agreement and
position within the Company, previous option activity, the number of shares
currently owned and the expected time of when those options would be exercised.
The Company has not paid cash dividends. The Company estimates the forfeiture
rate in calculating the compensation expense to be insignificant. In 2007 the
Company granted 30,000 stock options using a risk free rate of 4.98%,
volatility rate of 34.79% and forfeiture rate of 2%. This resulted in a fair
market value under the black-scholes model of $9.22 per option.

Table 1
illustrates the effect on net income and earnings per share for the year ended
December 31, 2005 as if the Company had applied the fair value recognition
provisions of SFAS 123(R) to options granted under the Companys stock option plan.

|                                                                                                                                                  |  |      |       | 
|------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ----- | 
|Table 1: 2005 Proforma Net Income                                                                                                                
|                                                                                                                                                 
|                                                                                                                                                 
|                                                                                                                                                  |  | 2005 |      
|                                                                                                                                                  |  |      |      
|(In thousands, except per share amounts)                                                                                                          |  |      |       | 
|Net income, as reported                                                                                                                           |  | $    | 4,286 | 
|Deduct: Total stock-based employee
 compensation expense determined under the fair value based method for all
 awards, net of related tax effects |  |      | 264   | 
|                                                                                                                                                  |  |      |       | 
|Pro forma net income                                                                                                                              |  | $    | 4,022 | 
|                                                                                                                                                  |  |      |       | 
|                                                                                                                                                  |  |      |       | 
|Basic earnings per share  as reported                                                                                                            |  | $    | 1.23  | 
|Basic earnings per share - pro forma                                                                                                              |  | $    | 1.16  | 
|                                                                                                                                                  |  |      |       | 
|Diluted earnings per share - as reported                                                                                                          |  | $    | 1.10  | 
|Diluted earnings per share - pro forma                                                                                                            |  | $    | 1.03  | 
|                                                                                                                                                  |  |      |       | 

14

---



PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(CONTINUED)

NEW FINANCIAL ACCOUNTING STANDARDS

Fair Value Measurements

In September
2006, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 157, Fair Value Measurements (SFAS No.
157). SFAS No. 157 defines fair value, establishes a framework for measuring
fair value, and expands disclosures about fair value measurement. SFAS No. 157
also emphasizes that fair value is a market-based measurement, not an
entity-specific measurement, and sets out a fair value hierarchy with the
highest priority being quoted prices in active markets. Under SFAS No. 157,
fair value measurements are disclosed by level within that hierarchy. SFAS No.
157 is effective for fiscal years beginning after November 15, 2007, except for
nonfinancial assets and nonfinancial liabilities that are recognized or
disclosed at fair value in the financial statements on a nonrecurring basis for
which delayed application is permitted until fiscal years beginning after
November 15, 2008. The adoption of SFAS No. 157 is not expected to have a
material impact on the Companys financial position, results of operations or
cash flows.

Fair Value Accounting

In February
2007, the FASB issued Statement of Financial Accounting Standards No. 159, The
Fair Value Option for Financial Assets and Financial Liabilities (SFAS No.
159). SFAS No. 159 permits companies to elect to follow fair value accounting
for certain financial assets and liabilities in an effort to mitigate
volatility in earnings without having to apply complex hedge accounting
provisions. The standard also establishes presentation and disclosure requirements
designed to facilitate comparison between entities that choose different
measurement attributes for similar types of assets and liabilities. SFAS No.
159 is effective for fiscal years beginning after November 15, 2007. SFAS No.
159 is not expected to have a material impact on the Companys financial
position, results of operations or cash flows.

Business Combinations

In December
2007, the FASB issued Statement of Financial Accounting Standards No. 141
(revised 2007), Business Combinations (SFAS No. 141(R)). SFAS No. 141(R),
among other things, establishes principles and requirements for how the
acquirer in a business combination (i) recognizes and measures in its financial
statements the identifiable assets acquired, the liabilities assumed, and any
noncontrolling interest in the acquired business, (ii) recognizes and measures
the goodwill acquired in the business combination or a gain from a bargain
purchase, and (iii) determines what information to disclose to enable users of
the financial statements to evaluate the nature and financial effects of the
business combination. The Company is required to adopt SFAS No. 141(R) for all
business combinations for which the acquisition date is on or after January 1,
2009. Earlier adoption is prohibited. This standard will change the Companys
accounting treatment for business combinations on a prospective basis.

Noncontrolling Interests in Consolidated
Financial Statements

In December
2007, the FASB issued Statement of Financial Accounting Standards No. 160,
Noncontrolling Interests in Consolidated Financial Statements, an Amendment of
ARB No. 51 (SFAS No. 160). SFAS No. 160 establishes accounting and reporting
standards for noncontrolling interests in a subsidiary and for the
deconsolidation of a subsidiary. Minority interests will be recharacterized as
noncontrolling interests and classified as a component of equity. It also
establishes a single method of accounting for changes in a parents ownership
interest in a subsidiary and requires expanded disclosures. This statement is
effective for fiscal years beginning on or after December 15, 2008, with early
adoption prohibited. The Company does not expect the adoption of this Statement
will have a material impact on its financial position, results of operations or
cash flows.

15

---



PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(CONTINUED)

Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance
Arrangements

In September
2006, the FASB ratified the Emerging Issues Task Force (EITF) conclusion
under EITF Issue No. 06-4, Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance
Arrangements (EITF 06-4). EITF 06-4 requires that endorsement split-dollar
life insurance arrangements which provide a postretirement benefit to an
employee be recorded in accordance with FASB Statement No. 106, Employers
Accounting for Postretirement Benefits Other Than Pensions or APB Opinion No.
12, Omnibus Opinion1967, based on the substance of the agreement with the
employee. Under the provisions of these Statements, if the employer has
effectively agreed to maintain a life insurance policy during the employees
retirement, the cost of the insurance policy during postretirement periods
should be accrued in accordance with either Statement 106 or Opinion 12.
Similarly, if the employer has effectively agreed to provide the employee with
a death benefit, the employer should accrue, over the service period, a
liability for the actuarial present value of the future death benefit as of the
employees expected retirement date, in accordance with either Statement 106 or
Opinion 12. EITF 06-4 is effective for fiscal years beginning after December
15, 2007. The effects of adopting EITF 06-4 can be recorded either as (i) a
change in accounting principle through a cumulative-effect adjustment to
retained earnings or to other components of equity as of the beginning of the
year of adoption, or (ii) a change in accounting principle through
retrospective application to all prior periods. The Company adopted the
provisions of EITF 06-4 as of January 1, 2008 and management determined that
adoption will not have an impact on the financial position, results of
operations or cash flows of the Company.

Accounting for Collateral Assignment
Split-Dollar Life Insurance Arrangements

In March 2007,
the FASB ratified the consensus the EITF reached regarding EITF Issue No.
06-10, Accounting for Collateral Assignment Split-Dollar Life Insurance
Arrangements (EITF 06-10), which provides accounting guidance for
postretirement benefits related to collateral assignment split-dollar life
insurance arrangements, whereby the employee owns and controls the insurance policies.
The consensus concludes that an employer should recognize a liability for the
postretirement benefit in accordance with FASB Statement No. 106, Employers
Accounting for Postretirement Benefits Other Than Pensions, or APB Opinion No.
12, Omnibus Opinion  1967, as well as recognize an asset based on the
substance of the arrangement with the employee. EITF 06-10 is effective for
fiscal years beginning after December 15, 2007, with early application
permitted. The Company adopted the provisions of EITF 06-10 on January 1, 2008
and management determined that adoption will not have an impact on the
financial position, results of operations or cash flows of the Company.

16

---



PACIFIC STATE BANCORP AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)

|                               
|-------------------------------
|NOTE 3.
  INVESTMENT SECURITIES
|                               

The amortized cost and
estimated fair value of investment securities at December 31, 2007 and 2006
consisted of the following:

|                            
|----------------------------
|AVAILABLE-FOR-SALE
  (AFS)
|                            

Table 2: 2007 AFS Securities

|                                                  |  |                  |        |                            |   |                             |  |                          |      |   |   |        | 
|------------------------------------------------- |  | ---------------- | ------ | -------------------------- | - | --------------------------- |  | ------------------------ | ---- | - | - | ------ | 
|                                                  |  |                  |       
|                                                  |  | Amortized
  Cost |        | Gross
  Unrealized
  Gains |   | Gross
  Unrealized
  Losses |  | Estimated
  Fair
  Value |     
|                                                  |  |                  |        |                            |   |                             |  |                          |     
|                                                  |  | (In thousands)   |       
|                                                  |  |                  |        |                            |   |                             |  |                          |      |   |   |        | 
|Debt securities:                                  |  |                  |        |                            |   |                             |  |                          |      |   |   |        | 
|U.S. Treasury securities                          |  | $                | 17,424 |                            | $ | 58                          |  | $                        |     |   | $ | 17,482 | 
|U.S. Government agencies                          |  |                  | 2,946  |                            |   | 4                           |  |                          | (15  | ) |   | 2,935  | 
|Obligations of states and political
sub-divisions |  |                  | 3,059  |                            |   | 102                         |  |                          |     |   |   | 3,161  | 
|Mortgage-backed securities                        |  |                  | 8,754  |                            |   | 47                          |  |                          | (677 | ) |   | 8,124  | 
|Corporate bonds                                   |  |                  | 9,755  |                            |   |                            |  |                          | (163 | ) |   | 9,592  | 
|                                                  |  |                  |        |                            |   |                             |  |                          |      |   |   |        | 
|                                                  |  | $                | 41,938 |                            | $ | 211                         |  | $                        | (855 | ) | $ | 41,294 | 
|                                                  |  |                  |        |                            |   |                             |  |                          |      |   |   |        | 

Net unrealized losses on
available-for-sale investment securities totaling $644,000 were recorded, net
of $258,000 in tax benefit, as accumulated other comprehensive loss within
shareholders equity at December 31, 2007. There were no proceeds or gross
realized gains or losses from the sale or call of available-for-sale investment
securities for the year ended December 31, 2007.

Table 3: 2006 AFS Securities

|                                                  |  |                  |        |                            |   |                             |  |                          |      |   |   |        | 
|------------------------------------------------- |  | ---------------- | ------ | -------------------------- | - | --------------------------- |  | ------------------------ | ---- | - | - | ------ | 
|                                                  |  |                  |       
|                                                  |  | Amortized
  Cost |        | Gross
  Unrealized
  Gains |   | Gross
  Unrealized
  Losses |  | Estimated
  Fair
  Value |     
|                                                  |  |                  |        |                            |   |                             |  |                          |     
|                                                  |  | (In thousands)   |       
|                                                  |  |                  |        |                            |   |                             |  |                          |      |   |   |        | 
|Debt securities:                                  |  |                  |        |                            |   |                             |  |                          |      |   |   |        | 
|U.S. Treasury securities                          |  | $                | 10,902 |                            | $ |                            |  | $                        | (26  | ) | $ | 10,876 | 
|U.S. Government agencies                          |  |                  | 2,974  |                            |   |                            |  |                          | (117 | ) |   | 2,857  | 
|Obligations of states and political
sub-divisions |  |                  | 2,646  |                            |   | 181                         |  |                          | (67  | ) |   | 2,760  | 
|Mortgage-backed securities                        |  |                  | 4,073  |                            |   |                            |  |                          | (38  | ) |   | 4,035  | 
|Corporate bonds                                   |  |                  | 2,518  |                            |   |                            |  |                          | (12  | ) |   | 2,506  | 
|                                                  |  |                  |        |                            |   |                             |  |                          |      |   |   |        | 
|                                                  |  | $                | 23,113 |                            | $ | 181                         |  | $                        | (260 | ) | $ | 23,034 | 
|                                                  |  |                  |        |                            |   |                             |  |                          |      |   |   |        | 

Net unrealized losses on
available-for-sale investment securities totaling $79,000 were recorded, net of
$32,000 in tax benefit, as accumulated other comprehensive loss within
shareholders equity at December 31, 2006. There were no proceeds or gross
realized gains or losses from the sale or call of available-for-sale investment
securities for the years ended December 31, 2006 and 2005.

|  
|--
|  
|  
|17

---



PACIFIC STATE BANCORP AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)

|                        
|------------------------
|HELD-TO-MATURITY (HTM)
|                        

Table 4: 2007 HTM Securities

|                           |  |                  |    |                            |   |                             |  |                          |   |  |   |    | 
|-------------------------- |  | ---------------- | -- | -------------------------- | - | --------------------------- |  | ------------------------ | - |  | - | -- | 
|                           |  |                  |   
|                           |  | Amortized
  Cost |    | Gross
  Unrealized
  Gains |   | Gross
  Unrealized
  Losses |  | Estimated
  Fair
  Value |  
|                           |  |                  |    |                            |   |                             |  |                          |  
|                           |  | (In thousands)   |   
|                           |  |                  |    |                            |   |                             |  |                          |   |  |   |    | 
|Debt securities:           |  |                  |    |                            |   |                             |  |                          |   |  |   |    | 
|Mortgage-backed securities |  | $                | 58 |                            | $ |                            |  | $                        |  |  | $ | 58 | 
|                           |  |                  |    |                            |   |                             |  |                          |   |  |   |    | 

Table 5: 2006 HTM Securities

|                           |  |                  |    |                            |   |                             |  |                          |    |   |   |    | 
|-------------------------- |  | ---------------- | -- | -------------------------- | - | --------------------------- |  | ------------------------ | -- | - | - | -- | 
|                           |  |                  |   
|                           |  | Amortized
  Cost |    | Gross
  Unrealized
  Gains |   | Gross
  Unrealized
  Losses |  | Estimated
  Fair
  Value |   
|                           |  |                  |    |                            |   |                             |  |                          |   
|                           |  | (In thousands)   |   
|                           |  |                  |    |                            |   |                             |  |                          |    |   |   |    | 
|Debt securities:           |  |                  |    |                            |   |                             |  |                          |    |   |   |    | 
|Mortgage-backed securities |  | $                | 73 |                            | $ |                             |  | $                        | (1 | ) | $ | 72 | 
|                           |  |                  |    |                            |   |                             |  |                          |    |   |   |    | 

|                                                                                                                                                                     
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|There were no sales or
  transfers of held-to-maturity investment securities during the years ended
  December 31, 2007, 2006 and 2005.                              
|                                                                                                                                                                     
|                                                                                                                                                                     
|                                                                                                                                                                     
|Investment securities with
  unrealized losses at December 31, 2007 and 2006 are summarized and classified
  according to the duration of the loss period as follows:

Table 6: 2007 Unrealized Security Losses

|                           |  |                     |       |                     |   |              |   |                     |       |              |   |                     |   |   |       |  |   |      |  
|-------------------------- |  | ------------------- | ----- | ------------------- | - | ------------ | - | ------------------- | ----- | ------------ | - | ------------------- | - | - | ----- |  | - | ---- | -
|                           |  | Less than 12 Months |       | 12 Months or More   |   | Total        |  
|                           |  |                     |       |                     |   |              |  
|                           |  | Fair
  Value        |       | Unrealized
  Losses |   | Fair
  Value |   | Unrealized
  Losses |       | Fair
  Value |   | Unrealized
  Losses |  
|                           |  |                     |       |                     |   |              |   |                     |       |              |   |                     |  
|                           |  | (In thousands)      |      
|                           |  |                     |       |                     |   |              |   |                     |       |              |   |                     |   |   |       |  |   |      |  
|Debt securities:           |  |                     |       |                     |   |              |   |                     |       |              |   |                     |   |   |       |  |   |      |  
|U.S. Government Agencies   |  | $                   | 993   |                     | $ | (7           | ) | $                   | 884   |              | $ | (8                  | ) | $ | 1,877 |  | $ | (15  | )
|Mortgage-backed securities |  |                     | 5,393 |                     |   | (664         | ) |                     | 880   |              |   | (13                 | ) |   | 6,273 |  |   | (677 | )
|Corporate bonds            |  |                     | 2,080 |                     |   | (79          | ) |                     | 930   |              |   | (84                 | ) |   | 3,010 |  |   | (163 | )
|                           |  |                     |       |                     |   |              |   |                     |       |              |   |                     |   |   |       |  |   |      |  
|                           |  | $                   | 7,473 |                     | $ | (750         | ) | $                   | 1,810 |              | $ | (105                | ) | $ | 9,283 |  | $ | (855 | )
|                           |  |                     |       |                     |   |              |   |                     |       |              |   |                     |   |   |       |  |   |      |  

Table 7: 2006 Unrealized Security Losses

|                                                  |  |                     |        |                     |   |              |   |                     |        |              |   |                     |   |   |        |  |   |      |  
|------------------------------------------------- |  | ------------------- | ------ | ------------------- | - | ------------ | - | ------------------- | ------ | ------------ | - | ------------------- | - | - | ------ |  | - | ---- | -
|                                                  |  | Less than 12 Months |        | 12 Months or More   |   | Total        |  
|                                                  |  |                     |        |                     |   |              |  
|                                                  |  | Fair
  Value        |        | Unrealized
  Losses |   | Fair
  Value |   | Unrealized
  Losses |        | Fair
  Value |   | Unrealized
  Losses |  
|                                                  |  |                     |        |                     |   |              |   |                     |        |              |   |                     |  
|                                                  |  | (In thousands)      |       
|                                                  |  |                     |        |                     |   |              |   |                     |        |              |   |                     |   |   |        |  |   |      |  
|Debt securities:                                  |  |                     |        |                     |   |              |   |                     |        |              |   |                     |   |   |        |  |   |      |  
|U.S. Treasury securities                          |  | $                   | 7,895  |                     | $ | (11          | ) | $                   | 2,981  |              | $ | (15                 | ) | $ | 10,876 |  | $ | (26  | )
|U.S. Government agencies                          |  |                     |       |                     |   |             |   |                     | 2,974  |              |   | (117                | ) |   | 2,974  |  |   | (117 | )
|Obligations of states and political
sub-divisions |  |                     | 1,357  |                     |   | (64          | ) |                     | 203    |              |   | (3                  | ) |   | 1,560  |  |   | (67  | )
|Mortgage-backed securities                        |  |                     |       |                     |   |             |   |                     | 4,035  |              |   | (38                 | ) |   | 4,035  |  |   | (38  | )
|Corporate bonds                                   |  |                     | 1,506  |                     |   | (12          | ) |                     |        |              |   |                     |   |   | 1,506  |  |   | (12  | )
|                                                  |  |                     |        |                     |   |              |   |                     |        |              |   |                     |   |   |        |  |   |      |  
|                                                  |  | $                   | 10,758 |                     | $ | (87          | ) | $                   | 10,193 |              | $ | (173                | ) | $ | 20,951 |  | $ | (260 | )
|                                                  |  |                     |        |                     |   |              |   |                     |        |              |   |                     |   |   |        |  |   |      |  

U.S. Government Agency Securities

At December 31, 2007, the
Company held 5 U.S. Government Agency Securities of which 1 was in a loss
position for less than twelve months and 3 were in a loss position and had been
in a loss position for twelve months or more. Management believes the
unrealized losses on the Companys investments in U.S. Government Agency Securities
were caused by interest rate increases and is not attributable to changes in
credit quality. Because the decline in market value is attributable to changes
in interest rates and not credit quality, and because the Company has the
ability and intent to hold these investments until a recovery of fair value,
which may be maturity, the Company does not consider these investments to be
other-than-temporarily impaired at December 31, 2007.

18

---



PACIFIC STATE BANCORP AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)

Mortgage-Backed Securities

At December 31, 2007, the
Company held 9 mortgage-backed investment securities of which 4 were in a loss
position for less than twelve months and 1 was in a loss position and had been
in a loss position for twelve months or more. Management believes that the
unrealized losses on the Companys investments in mortgage-backed investment
securities were caused by interest rate increases and is not attributable to
changes in credit quality. The contractual cash flows of those investments are
guaranteed by an agency of the U.S. government. Because the decline in market
value is attributable to changes in interest rates and not credit quality, and
because the Company has the ability and intent to hold those investments until
a recovery of fair value, which may be maturity, the Company does not consider
those investments to be other-than-temporarily impaired at December 31, 2007.

Corporate Bonds

At December 31, 2007, the
Company held 6 corporate debt securities, of which 4 were in an unrealized loss
position. Management believes the unrealized losses on the Companys
investments in corporate bands were caused by interest rate increases and is
not attributable to changes in credit quality. Because the decline in market
value is attributable to changes in interest rates and not credit quality, and
because the Company has the ability and intent to hold these investments until
a recovery of fair value, which may be maturity, the Company does not consider
these investments to be other-than-temporarily impaired at December 31, 2007.

The amortized cost and
estimated fair value of investment securities at December 31, 2007 by
contractual maturity are shown below. Expected maturities will differ from
contractual maturities because the issuers of the securities may have the right
to call or prepay obligations with or without call or prepayment penalties.

Table 8: Security Maturity Schedule

|                                                           |  |                    |        |                          |   |                  |  |                          |    |  |   |    | 
|---------------------------------------------------------- |  | ------------------ | ------ | ------------------------ | - | ---------------- |  | ------------------------ | -- |  | - | -- | 
|                                                           |  | Available-for-Sale |        | Held-to-Maturity         |  
|                                                           |  |                    |        |                          |  
|                                                           |  | Amortized
  Cost   |        | Estimated
  Fair
  Value |   | Amortized
  Cost |  | Estimated
  Fair
  Value |   
|                                                           |  |                    |        |                          |   |                  |  |                          |   
|                                                           |  | (In thousands)     |       
|                                                           |  |                    |        |                          |   |                  |  |                          |    |  |   |    | 
|Within one year                                            |  | $                  | 18,059 |                          | $ | 18,117           |  | $                        |   |  | $ |   | 
|After one year through
  five years                        |  |                    | 1,201  |                          |   | 1,206            |  |                          |   |  |   |   | 
|After five years through
  ten years                       |  |                    |       |                          |   |                 |  |                          |   |  |   |   | 
|After ten years                                            |  |                    | 13,924 |                          |   | 13,847           |  |                          |   |  |   |   | 
|                                                           |  |                    |        |                          |   |                  |  |                          |    |  |   |    | 
|                                                           |  |                    | 33,184 |                          |   | 33,170           |  |                          |   |  |   |   | 
|Investment securities not
  due at a single maturity date: |  |                    |        |                          |   |                  |  |                          |    |  |   |    | 
|Mortgage-backed securities                                 |  |                    | 8,754  |                          |   | 8,124            |  |                          | 58 |  |   | 58 | 
|                                                           |  |                    |        |                          |   |                  |  |                          |    |  |   |    | 
|                                                           |  | $                  | 41,938 |                          | $ | 41,294           |  | $                        | 58 |  | $ | 58 | 
|                                                           |  |                    |        |                          |   |                  |  |                          |    |  |   |    | 

Investment
securities with amortized costs totaling $20,942,000 and $13,749,000 and
estimated market values totaling $20,984,000 and $13,640,000 were pledged to
secure treasury tax and loan accounts, public deposits and Federal Reserve Bank
at December 31, 2007 and 2006, respectively. Certain other investment
securities are pledged to secure borrowings with the Federal Home Loan Bank
(see Note 7).

19

---



PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)

|                                           
|-------------------------------------------
|NOTE 4. LOANS AND ALLOWANCE FOR LOAN LOSSES
|                                           

Outstanding
loans are summarized below:

Table 9: Loans Outstanding by Category

|                                            |  |                |         |      |   |         |  
|------------------------------------------- |  | -------------- | ------- | ---- | - | ------- | -
|                                            |  | December 31,   |        
|                                            |  | 2007           |         | 2006 |  
|                                            |  |                |         |      |  
|                                            |  | (In thousands) |        
|                                           
|Commercial                                  |  | $              | 83,012  |      | $ | 72,172  |  
|Agricultural                                |  |                | 12,646  |      |   | 16,873  |  
|Real estate - commercial mortgage           |  |                | 121,157 |      |   | 112,531 |  
|Real estate - construction                  |  |                | 80,168  |      |   | 75,654  |  
|Installment                                 |  |                | 15,215  |      |   | 12,526  |  
|                                            |  |                |         |      |   |         |  
|Gross loans                                 |  |                | 312,198 |      |   | 289,756 |  
|Deferred loan origination (fees) costs, net |  |                | 208     |      |   | 40      |  
|Allowance for loan losses                   |  |                | (3,948  | )    |   | (2,478  | )
|                                            |  |                |         |      |   |         |  
|Net loans                                   |  | $              | 308,458 |      | $ | 287,318 |  
|                                            |  |                |         |      |   |         |  

Changes in the
allowance for loan losses were as follows:

Table 10: Changes in Allowance for Loan Losses

|                                                       |  |                         |       |      |   |       |   |   |       |  
|------------------------------------------------------ |  | ----------------------- | ----- | ---- | - | ----- | - | - | ----- | -
|                                                       |  | Year Ended December 31, |      
|                                                       |  |                         |      
|                                                       |  | 2007                    |       | 2006 |   | 2005  |  
|                                                       |  |                         |       |      |   |       |  
|                                                       |  | (In thousands)          |      
|                                                      
|Balance, beginning of year                             |  | $                       | 2,478 |      | $ | 2,356 |   | $ | 2,214 |  
|Provision charged to operations                        |  |                         | 1,425 |      |   | 360   |   |   | 35    |  
|Losses charged to allowance                            |  |                         | (161  | )    |   | (24   | ) |   | (17   | )
|Recoveries                                             |  |                         | 206   |      |   | 1     |   |   | 124   |  
|Reclassification of reserve for unfunded
  commitments |  |                         |      |      |   | (215  | ) |   |      |  
|                                                       |  |                         |       |      |   |       |   |   |       |  
|Balance, end of year                                   |  | $                       | 3,948 |      | $ | 2,478 |   | $ | 2,356 |  
|                                                       |  |                         |       |      |   |       |   |   |       |  

There was one
loan on nonaccrual status in the amount of $432,000 as of December 31, 2007.
There were no loans considered impaired at December 31, 2006 and 2005. The
Company did not recognize any interest income on impaired or nonaccrual loans
during 2007, 2006 and 2005.

The
interest foregone on nonaccrual loans was not significant at December 31, 2007,
2006 and 2005.

Salaries
and employee benefits totaling $1,006,000, $227,000, and $263,000 have been
deferred as loan origination costs for the years ended December 31, 2007, 2006
and 2005, respectively.

20

---



PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)

|                              
|------------------------------
|NOTE 5. PREMISES AND EQUIPMENT
|                              

Premises and
equipment consisted of the following:

Table 11: Premises and Equipment

|                                                 |  |              |        |      |   |        |  
|------------------------------------------------ |  | ------------ | ------ | ---- | - | ------ | -
|                                                 |  | December 31, |       
|                                                 |  |              |       
|(In thousands)                                   |  | 2007         |        | 2006 |  
|                                                 |  |              |        |      |  
|                                                 |  |              |        |      |   |        |  
|Land                                             |  | $            | 4,956  |      | $ | 3,047  |  
|Buildings and improvements                       |  |              | 5,987  |      |   | 4,669  |  
|Furniture, fixtures and equipment                |  |              | 4,525  |      |   | 4,264  |  
|Leasehold improvements                           |  |              | 1,807  |      |   | 1,802  |  
|Construction in progress                         |  |              | 1,879  |      |   | 2,364  |  
|                                                 |  |              |        |      |   |        |  
|Total gross premises and equipment               |  |              | 19,154 |      |   | 16,146 |  
|Less accumulated depreciation and
  amortization |  |              | (4,885 | )    |   | (4,189 | )
|                                                 |  |              |        |      |   |        |  
|Total premises and equipment                     |  | $            | 14,269 |      | $ | 11,957 |  
|                                                 |  |              |        |      |   |        |  

Depreciation
and amortization included in occupancy, furniture and equipment expense totaled
$745,000, $682,000 and $632,000 for the years ended December 31, 2007, 2006 and
2005, respectively.

|                                 
|---------------------------------
|NOTE 6. INTEREST-BEARING DEPOSITS
|                                 

Interest-bearing
deposits consisted of the following:

Table 12: Interest Bearing Deposits

|                                |  |              |         |      |   |         | 
|------------------------------- |  | ------------ | ------- | ---- | - | ------- | 
|                                |  | December 31, |        
|                                |  |              |        
|(In thousands)                  |  | 2007         |         | 2006 |  
|                                |  |              |         |      |  
|                                |  |              |         |      |   |         | 
|Savings                         |  | $            | 5,154   |      | $ | 5,705   | 
|Money market                    |  |              | 54,411  |      |   | 68,850  | 
|NOW accounts                    |  |              | 18,096  |      |   | 18,873  | 
|Time deposits, $100,000 or more |  |              | 127,731 |      |   | 114,768 | 
|Time deposits under $100,000    |  |              | 69,358  |      |   | 59,603  | 
|                                |  |              |         |      |   |         | 
|Total interest bearing deposits |  | $            | 274,750 |      | $ | 267,799 | 
|                                |  |              |         |      |   |         | 

Aggregate
annual maturities of time deposits are as follows (in thousands):

Table 13: Time Deposit Maturity Schedule

|                    |  |                               |         | 
|------------------- |  | ----------------------------- | ------- | 
|                    |  | Year Ending
December 31, 2007 |        
|                    |  |                               |        
|                   
|2008                |  | $                             | 174,415 | 
|2009                |  |                               | 12,802  | 
|2010                |  |                               | 1,882   | 
|2011                |  |                               | 2,769   | 
|2012                |  |                               | 5,183   | 
|Thereafter          |  |                               | 38      | 
|                    |  |                               |         | 
|Total time deposits |  | $                             | 197,089 | 
|                    |  |                               |         | 

21

---



PACIFIC STATE BANCORP AND SUBSIDIARY 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(CONTINUED)

Interest
expense recognized on interest-bearing deposits consisted of the following:

|                                   |  |              |        |      |   |       |  |   |       | 
|---------------------------------- |  | ------------ | ------ | ---- | - | ----- |  | - | ----- | 
|Table 14: Deposit Interest Expense |  | December 31, |       
|                                   |  |              |       
|(In thousands)                     |  | 2007         |        | 2006 |   | 2005  | 
|                                   |  |              |        |      |   |       | 
|                                   |  |              |        |      |   |       |  |   |       | 
|Savings                            |  | $            | 46     |      | $ | 56    |  | $ | 36    | 
|Money market                       |  |              | 1,985  |      |   | 2,122 |  |   | 2,147 | 
|NOW accounts                       |  |              | 246    |      |   | 315   |  |   | 237   | 
|Time
  deposits, $100,000 or more  |  |              | 6,657  |      |   | 3,906 |  |   | 1,248 | 
|Time
  deposits under $100,000     |  |              | 3,910  |      |   | 1,703 |  |   | 942   | 
|                                   |  |              |        |      |   |       |  |   |       | 
|Total
  deposit interest expense   |  | $            | 12,844 |      | $ | 8,102 |  | $ | 4,610 | 
|                                   |  |              |        |      |   |       |  |   |       | 

|                        
|------------------------
|NOTE 7. OTHER BORROWINGS
|                        

The Company
has unsecured short-term borrowing arrangements totaling $26,000,000 with four
of its correspondent banks. There were no borrowings outstanding under these
arrangements at December 31, 2007 and 2006.

The
Company has a borrowing arrangement with the Federal Home Loan Bank of San
Francisco (FHLB) which allow the Company to borrow on either a short-term or
long-term basis up to approximately $77,886,000 and $11,349,000 as of December
31, 2007 and 2006 respectively based on specific percentages of the collateral
pledged. For the years ended December 31, 2007 and 2006, various residential
mortgage loans totaling approximately $71,741,000 and $8,018,000 and investment
securities totaling approximately $6,145,000 and $5,911,000, respectively,
secured this borrowing arrangement. The Bank had an outstanding letter of
credit with the Federal Home Loan Bank in the amount of $282,000 at December
31, 2007.

Advances from
the FHLB at December 31, 2007 and 2006 consisted of the following:

Table 15: FHLB Advances (Dollars in thousands)

|             |        |      |  |               |   |         |                   |      |   |               |  |  |      |   |  |              | 
|------------ | ------ | ---- |  | ------------- | - | ------- | ----------------- | ---- | - | ------------- |  |  | ---- | - |  | ------------ | 
|December 31, |       
|             |       
|2007         |        | 2006 | 
|             |        |      | 
|Balance      |        | Rate |  | Maturity Date |   | Balance |                   | Rate |   | Maturity Date | 
|             |        |      |  |               |   |         |                   |      |   |               | 
|            
|$            | 35,000 |      |  | 3.80          | % |         | January 2, 2008   |      | $ | 4,900         |  |  | 5.26 | % |  | May 16, 2007 | 
|             | 2,500  |      |  | 4.41          | % |         | December 17, 2012 |      |   |               |  |  |      |   |  |              | 
|             | 2,500  |      |  | 4.28          | % |         | December 18, 2012 |      |   |               |  |  |      |   |  |              | 
|             |        |      |  |               |   |         |                   |      |   |               |  |  |      |   |  |              | 
|$            | 40,000 |      |  |               |   |         |                   |      | $ | 4,900         |  |  |      |   |  |              | 
|             |        |      |  |               |   |         |                   |      |   |               |  |  |      |   |  |              | 

22

---



PACIFIC STATE BANCORP AND SUBSIDIARY 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(CONTINUED)

|                               
|-------------------------------
|NOTE 8. SUBORDINATED DEBENTURES
|                               

The following
is a summary of the subordinated debentures payable to the Companys subsidiary
grantor trusts at December 31, 2007 and 2006 (dollars in thousands):

|                                                                                                                                                                                                                                                                |  |              |       |      |   |       | 
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ----- | ---- | - | ----- | 
|Table 16: Subordinated Debentures Outstanding                                                                                                                                                                                                                   |  | December 31, |      
|                                                                                                                                                                                                                                                                |  |              |      
|                                                                                                                                                                                                                                                                |  | 2007         |       | 2006 |  
|                                                                                                                                                                                                                                                                |  |              |       |      |  
|Subordinated
  debentures due to Pacific State Statutory Trust I with interest payable
  semi-annually based on 6-month LIBOR plus 3.45% to a maximum of 11.95% prior
  to June 26, 2007 (Retired on June 26, 2007 with no premium).                            |  | $            |      |      | $ | 5,155 | 
|                                                                                                                                                                                                                                                                |  |              |       |      |   |       | 
|Subordinated
  debentures due to Pacific State Statutory Trust II with interest payable
  quarterly based on 3-month LIBOR plus 2.79% (7.78% at December 31, 2007), and
  redeemable with no premium beginning March 17, 2009 and due March 17, 2034            |  |              | 3,609 |      |   | 3,609 | 
|                                                                                                                                                                                                                                                                |  |              |       |      |   |       | 
|                                                                                                                                                                                                                                                                |  |              |       |      |   |       | 
|Subordinated
  debentures due to Pacific State Statutory Trust III with interest payable
  quarterly based on 3-month LIBOR plus 1.45% (6.44% at December 31, 2007), and
  redeemable with no premium beginning September 16, 2012 and due September 16,
  2037 |  |              | 5,155 |      |   |      | 
|                                                                                                                                                                                                                                                                |  |              |       |      |   |       | 
|                                                                                                                                                                                                                                                                |  |              |       |      |   |       | 
|Total
  subordinated debentures                                                                                                                                                                                                                                 |  | $            | 8,764 |      | $ | 8,764 | 
|                                                                                                                                                                                                                                                                |  |              |       |      |   |       | 
|                                                                                                                                                                                                                                                                |  |              |       |      |   |       | 

Under
applicable regulatory guidance, the amount of trust preferred securities that
is eligible as Tier 1 capital is limited to twenty-five percent of the
Companys Tier 1 capital on a pro forma basis. At December 31, 2007, $8,509,000
of the trust preferred securities qualified as Tier 1 capital and $255,000
qualified as Tier 2 capital.

The
Company has guaranteed, on a subordinated basis, distributions and other
payments due on the trust preferred securities issued by the subsidiary grantor
trusts. Interest expense recognized by the Company for the years ended December
31, 2007, 2006 and 2005 related to the subordinated debentures was $702,000,
$710,000 and $527,000, respectively. The amount of deferred costs was $ 15,000
at December 31, 2007.

|                    
|--------------------
|NOTE 9. INCOME TAXES
|                    

The provision
for income taxes for the years ended December 31, 2007, 2006 and 2005 consisted
of the following:

|                               |  |         |       |                |   |       |   |   |       |  
|------------------------------ |  | ------- | ----- | -------------- | - | ----- | - | - | ----- | -
|Table 17: Income Tax Provision |  | Federal |       | State          |   | Total |  
|                               |  |         |       |                |   |       |  
|                               |  |         |       | (In thousands) |   |       |  
|2007                           |  |         |       |                |   |       |   |   |       |  
|Current                        |  | $       | 2,776 |                | $ | 873   |   | $ | 3,649 |  
|Deferred                       |  |         | (592  | )              |   | (163  | ) |   | (755  | )
|                               |  |         |       |                |   |       |   |   |       |  
|Provision for income taxes     |  | $       | 2,184 |                | $ | 710   |   | $ | 2,894 |  
|                               |  |         |       |                |   |       |   |   |       |  
|                               |  |         |       |                |   |       |   |   |       |  
|2006                           |  |         |       |                |   |       |   |   |       |  
|Current                        |  | $       | 2,671 |                | $ | 944   |   | $ | 3,615 |  
|Deferred                       |  |         | 54    |                |   | (42   | ) |   | 12    |  
|                               |  |         |       |                |   |       |   |   |       |  
|Provision for income taxes     |  | $       | 2,725 |                | $ | 902   |   | $ | 3,627 |  
|                               |  |         |       |                |   |       |   |   |       |  

|                           |  |   |       |   |   |     |   |   |       |  
|-------------------------- |  | - | ----- | - | - | --- | - | - | ----- | -
|2005                       |  |   |       |   |   |     |   |   |       |  
|Current                    |  | $ | 2,040 |   | $ | 687 |   | $ | 2,727 |  
|Deferred                   |  |   | (108  | ) |   | (23 | ) |   | (131  | )
|                           |  |   |       |   |   |     |   |   |       |  
|Provision for income taxes |  | $ | 1,932 |   | $ | 664 |   | $ | 2,596 |  
|                           |  |   |       |   |   |     |   |   |       |  

23

---



PACIFIC STATE BANCORP AND
SUBSIDIARY 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(CONTINUED)

Deferred tax
assets (liabilities) consisted of the following:

Table 18: Deferred Tax Assets and Liabilities

|                                                               |  |                |       |      |   |       |  
|-------------------------------------------------------------- |  | -------------- | ----- | ---- | - | ----- | -
|                                                               |  | December 31,   |      
|                                                               |  |                |      
|                                                               |  | 2007           |       | 2006 |  
|                                                               |  |                |       |      |  
|                                                               |  | (In thousands) |      
|Deferred tax assets:                                           |  |                |       |      |   |       |  
|Allowance for loan losses                                      |  | $              | 1,592 |      | $ | 953   |  
|Future benefit of state tax deduction                          |  |                | 124   |      |   | 145   |  
|Organization costs                                             |  |                |      |      |   | 3     |  
|Deposit purchase premium                                       |  |                | 111   |      |   | 103   |  
|Mark-to-market adjustment                                      |  |                |      |      |   |      |  
|Deferred compensation                                          |  |                | 563   |      |   | 385   |  
|Litigation reserve                                             |  |                |      |      |   |      |  
|Off balance sheet reserve                                      |  |                | 100   |      |   | 96    |  
|Bank premises and equipment                                    |  |                | 9     |      |   |      |  
|Unrealized losses on available-for-sale
 investment securities |  |                | 258   |      |   | 32    |  
|                                                               |  |                |       |      |   |       |  
|Total deferred tax assets                                      |  |                | 2,757 |      |   | 1,717 |  
|Deferred tax liabilities:                                      |  |                |       |      |   |       |  
|Bank premises and equipment                                    |  | $              |      |      | $ | (84   | )
|Mark to market adjustment                                      |  |                | (40   | )    |   |      |  
|Goodwill                                                       |  |                | (120  | )    |   | (98   | )
|FHLB dividends                                                 |  |                | (72   | )    |   | (48   | )
|Prepaid expense                                                |  |                | (218  | )    |   | (161  | )
|                                                               |  |                |       |      |   |       |  
|Total deferred tax liabilities                                 |  |                | (450  | )    |   | (391  | )
|                                                               |  |                |       |      |   |       |  
|Net deferred tax assets                                        |  | $              | 2,307 |      | $ | 1,326 |  
|                                                               |  |                |       |      |   |       |  

The Company
and its subsidiaries file income tax returns in the United States and
California jurisdictions. With few exceptions, the Company is no longer subject
to Federal income tax examinations for years before 2003 and State income tax
examinations by tax authorities for years before 2002.

The Company
adopted the provisions of FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes, on January 1, 2007. No adjustments were identified
for unrecognized tax benefits which would require an adjustment to the January
1, 2007 beginning tax reserve. The Company had no tax reserve for uncertain
positions at yearend. The Company does not anticipate providing a reserve for
uncertain positions in the next 12 months. In accordance with FIN 48, the
Company has elected to record interest accrued and penalties related to
unrecognized tax benefits in tax expense. During the years ended December 31,
2007 and 2006 the Company did not have an accrual for interest and/or penalties
associated with uncertain tax positions.

The provision
for income taxes differs from amounts computed by applying the statutory
Federal income tax rates to operating income before income taxes. The
significant items comprising these differences for the years ended December 31,
2007, 2006 and 2005 consisted of the following:

Table 19: Income Tax Rate Reconciliation

|                                                |  |      |      |      |  |      |    |  |      |   
|----------------------------------------------- |  | ---- | ---- | ---- |  | ---- | -- |  | ---- | --
|                                                |  | 2007 |      | 2006 |  | 2005 |   
|                                                |  |      |      |      |  |      |   
|                                               
|Federal
 income tax, at statutory rate          |  |      | 34.0 | %    |  | 34.0 | %  |  | 34.0 | % 
|State
 franchise tax, net of Federal tax effect |  |      | 6.3  | %    |  | 6.5  | %  |  | 6.3  | % 
|Tax exempt
 investment security income, net     |  |      | (0.4 | )%   |  | (0.7 | )% |  | (0.8 | )%
|Company
 owned life insurance, net              |  |      | (1.1 | )%   |  | (0.8 | )% |  | (0.9 | )%
|Other                                           |  |      | 0.1  | %    |  | 0.6  | %  |  | (0.8 | )%
|                                                |  |      |      |      |  |      |    |  |      |   
|Effective tax rate                              |  |      | 38.9 | %    |  | 39.6 | %  |  | 37.8 | % 
|                                                |  |      |      |      |  |      |    |  |      |   

24

---



PACIFIC STATE BANCORP AND
SUBSIDIARY 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(CONTINUED)

|                                      
|--------------------------------------
|NOTE 10. COMMITMENTS AND CONTINGENCIES
|                                      

LEASESThe Company leases branch offices and certain
equipment under non-cancelable operating leases. The leases expire on various
dates through 2016 and have various renewal options ranging from five to ten
years.

Future minimum
lease payments are as follows (in thousands):

Table 19: Future Lease Commitments

|             |  |   |       | 
|------------ |  | - | ----- | 
|Year Ending  |  |   |       | 
|December 31, |  |   |       | 
|             |  |   |       | 
|2008         |  | $ | 426   | 
|2009         |  |   | 274   | 
|2010         |  |   | 199   | 
|2011         |  |   | 205   | 
|2012         |  |   | 212   | 
|Thereafter   |  |   | 811   | 
|             |  |   |       | 
|Total        |  | $ | 2,127 | 
|             |  |   |       | 

Rental expense
included in occupancy, furniture and equipment expense totaled $383,000,
$319,000 and $276,000 for the years ended December 31, 2007, 2006 and 2005,
respectively.

FEDERAL RESERVE REQUIREMENTSBanks are required to maintain a combination of
reserves with the Federal Reserve Bank and vault cash equal to a percentage of
their reservable deposits. The reserve balances held with the Federal Reserve
Bank or in the form of vault cash totaled $3,951,000 and $4,552,000 as of
December 31, 2007 and 2006, respectively.

CORRESPONDENT BANKING AGREEMENTS

The Company
maintains funds on deposit with other federally insured financial institutions
under correspondent banking agreements. Uninsured deposits totaled $9,484,000
at December 31, 2007.

FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET
RISKThe Company is a party to financial instruments with
off-balance-sheet risk in the normal course of business in order to meet the
financing needs of its customers and to reduce its own exposure to fluctuations
in interest rates. These financial instruments consist of commitments to extend
credit and standby letters of credit. These instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amount
recognized on the balance sheet.

The
Companys exposure to credit loss in the event of nonperformance by the other
party for commitments to extend credit and standby letters of credit is
represented by the contractual amount of those instruments. The Company uses
the same credit policies in making commitments and standby letters of credit as
it does for loans included on the balance sheet.

The following
financial instruments represent off-balance-sheet credit risk:

Table 20: Commitments

|                               |  |                |         |      |   |         | 
|------------------------------ |  | -------------- | ------- | ---- | - | ------- | 
|                               |  | December 31,   |        
|                               |  |                |        
|                               |  | 2007           |         | 2006 |  
|                               |  |                |         |      |  
|                               |  | (In thousands) |        
|                              
|Commitments
 to extend
 credit |  | $              | 121,255 |      | $ | 110,937 | 
|Standby
 letters of credit     |  | $              | 3,491   |      | $ | 2,971   | 

Commitments to
extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments generally
have fixed expiration dates or other termination clauses and may require
payment of a fee. Since some of the commitments are expected to expire without
being drawn upon, the total commitment amounts do not necessarily represent
future cash requirements. The Company evaluates each customers creditworthiness
on a case-by-case basis. The amount of collateral obtained, if deemed necessary
by the Company upon extension of credit, is based on managements credit
evaluation of the borrower. Collateral held varies, but may include accounts
receivable, inventory, equipment, income-producing commercial properties and
residential real estate.

Standby
letters of credit are conditional commitments issued by the Company to
guarantee the performance or financial obligation of a customer to a third
party. The credit risk involved in issuing letters of credit is essentially the
same as that involved in extending loans to customers. The fair value of the
liability related to these standby letters of credit, which represents the fees
received for issuing the guarantees, was not significant at December 31, 2007
and 2006. The Company recognizes these fees as revenue over the term of the
commitment or when the commitment is used.

25

---



PACIFIC STATE BANCORP AND
SUBSIDIARY 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(CONTINUED)

At December
31, 2007, commercial loan commitments represent approximately 46% of total
commitments and are generally secured by various assets of the borrower. Real
estate loan commitments represent approximately 48% of total commitments and
are generally secured by property with a loan-to-value ratio not to exceed 75%
to 80%. Consumer loan commitments represent the remaining 6% of total
commitments and are generally unsecured. In addition, the majority of the
Companys commitments have variable interest rates.

CONCENTRATIONS OF CREDIT RISKThe Companys customers are primarily located in San
Joaquin, Stanislaus, Calaveras and Tuolumne Counties. At December 31, 2007,
approximately 27% of the Companys loans are for general commercial uses,
including professional, retail and small business, and 4% are for agricultural
uses. Additionally, 26% of the Companys loans are for the construction of
residential and commercial real estate and 39% are loans which are
collateralized by mortgages on residential and commercial real estate.
Generally, real estate loans are secured by real property while commercial and
other loans are secured by funds on deposit and business or personal assets.
The remaining 4% of the Companys loans are consumer installment loans. Repayment
is generally expected from the proceeds of property sales and permanent
financing for real estate construction loans and borrower cash flows for other
loans.

CONTINGENCIESThe Company is subject to legal proceedings and claims
which arise in the ordinary course of business. In the opinion of management,
the amount of ultimate liability with respect to such actions will not
materially affect the consolidated financial position or consolidated results
of operations of the Company.

|                             
|-----------------------------
|NOTE 11. SHAREHOLDERS EQUITY
|                             

DIVIDENDSThe Companys ability to pay cash dividends is
dependent on dividends paid to it by the Bank and limited by California
corporation law. Under California law, the holders of common stock of the
Company are entitled to receive dividends when and as declared by the Board of
Directors, out of funds legally available, subject to certain restrictions. The
California general corporation law prohibits the Company from paying dividends
on its common stock unless: (i) its retained earnings, immediately prior to the
dividend payment, equals or exceeds the amount of the dividend or (ii)
immediately after giving effect to the dividend, the sum of the Companys
assets (exclusive of goodwill and deferred charges) would be at least equal to
125% of its liabilities (not including deferred taxes, deferred income and
other deferred liabilities) and the current assets of the Company would be at
least equal to its current liabilities, or, if the average of its earnings
before taxes on income and before interest expense for the two preceding fiscal
years was less than the average of its interest expense for the two preceding
fiscal years, at least equal to 125% of its current liabilities. In addition,
the Companys ability to pay dividends is subject to certain covenants
contained in the indentures related to the trust preferred securities issued by
the Trusts.

Upon
declaration by the Board of Directors of the Company, all shareholders of
record will be entitled to receive dividends. A significant source of cash for
the Company is dividends from the Bank. The California Financial Code restricts
the total dividend payment of any bank in any calendar year to the lesser of
(1) the banks retained earnings or (2) the banks net income for its last three
fiscal years, less distributions made to shareholders during the same
three-year period. As a member of the Federal Reserve System, the Bank is also
subject to similar restrictions imposed by Federal law. At December 31, 2007,
Bank retained earnings of $15,186,000 were free of such restrictions and
available for dividend payments to Bancorp.

26

---



PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)

EARNINGS PER SHARE

A
reconciliation of the numerators and denominators of the basic and diluted
earnings per share computations is as follows:

Table 21: Earnings Per Share Calculation

|                                                                       |  |                                                    |           |      |   |           |  |   |           | 
|---------------------------------------------------------------------- |  | -------------------------------------------------- | --------- | ---- | - | --------- |  | - | --------- | 
|                                                                       |  | Year
Ended December 31,                            |          
|                                                                       |  |                                                    |          
|                                                                       |  | 2007                                               |           | 2006 |   | 2005      | 
|                                                                       |  |                                                    |           |      |   |           | 
|                                                                       |  | (In
thousands, except share and
per share amounts) |          
|Basic Earnings Per Share                                               |  |                                                    |           |      |   |           |  |   |           | 
|Numerator:                                                             |  |                                                    |           |      |   |           |  |   |           | 
|Net income                                                             |  | $                                                  | 4,549     |      | $ | 5,543     |  | $ | 4,286     | 
|Denominator:                                                           |  |                                                    |           |      |   |           |  |   |           | 
|Weighted average shares outstanding                                    |  |                                                    | 3,687,197 |      |   | 3,537,314 |  |   | 3,473,511 | 
|                                                                       |  |                                                    |           |      |   |           |  |   |           | 
|Basic earnings per share                                               |  | $                                                  | 1.23      |      | $ | 1.57      |  | $ | 1.23      | 
|                                                                       |  |                                                    |           |      |   |           |  |   |           | 
|                                                                       |  |                                                    |           |      |   |           |  |   |           | 
|Diluted Earnings Per Share                                             |  |                                                    |           |      |   |           |  |   |           | 
|Numerator:                                                             |  |                                                    |           |      |   |           |  |   |           | 
|Net income                                                             |  | $                                                  | 4,549     |      | $ | 5,543     |  | $ | 4,286     | 
|Denominator:                                                           |  |                                                    |           |      |   |           |  |   |           | 
|Weighted average shares outstanding                                    |  |                                                    | 3,687,197 |      |   | 3,537,314 |  |   | 3,473,511 | 
|Effect of dilutive stock options                                       |  |                                                    | 316,679   |      |   | 386,183   |  |   | 433,493   | 
|                                                                       |  |                                                    |           |      |   |           |  |   |           | 
|Weighted average shares of common stock and
  common stock equivalents |  |                                                    | 4,003,876 |      |   | 3,923,497 |  |   | 3,907,004 | 
|                                                                       |  |                                                    |           |      |   |           |  |   |           | 
|Diluted earnings per share                                             |  | $                                                  | 1.14      |      | $ | 1.41      |  | $ | 1.10      | 
|                                                                       |  |                                                    |           |      |   |           |  |   |           | 

30,000 stock
options were not included in the 2007 calculation as they were antidilutive.
All of the stock options outstanding were included in the computation of
diluted earnings per share for the years ended December 31, 2006 and 2005 as
none of the stock options were antidilutive.

STOCK OPTION PLAN

The Company currently has one
shareholder approved stock option plan, the Pacific State Bancorp 1997 Stock
Option Plan. At December 31, 2007, the plan has 663,769 shares remaining as
reserved for issuance for options already granted. Under the 1997 Plan 26,954
shares of common stock remain reserved for future issuance to employees and
directors through incentive and nonstatutory agreements. The plan requires that
the price may not be less than the fair market value of the Companys common
stock at the date of grant and that the stock must be paid in full at the time
the option is exercised. The Plans do not provided for the settlement of awards
in cash and new shares are issued upon the exercise of the options. There was
one grant of 30,000 stock options made in 2007 and no options were granted in
2006 or 2005. The options under the plans expire on dates determined by the
Board of Directors, but not later than ten years from the date of grant. The
vesting period is generally over five years.

STOCK OPTION COMPENSATION EXPENSE

The compensation cost that has
been charged against income for stock options was $309,000 and $229,000 for the
years ended December 31, 2007 and December 31, 2006, respectively. The total
income tax benefit recognized in shareholders equity for stock options
exercised was $223,000 and $736,000 for the years ended December 31, 2007 and
December 31, 2006, respectively.

At
December 31, 2007, the total compensation cost related to nonvested stock
option awards granted to employees under the Companys stock option plans but
not yet recognized was $460,000. Stock option compensation expense is
recognized on a straight-line basis over the vesting period of the option. This
cost is expected to be recognized over a weighted average remaining period of 2
years and will be adjusted for subsequent changes in estimated forfeitures. The
total fair value of options vested during the years ended December 31, 2007 and
December 31, 2006 was $309,000 and $229,000, respectively.

27

---



PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)

A summary of
the activity within the plans adjusted follows:

Table 22: Stock Option Activity

|                                       |  |        |         |                                 |   |        |  |                               |         |   |   |      | 
|-------------------------------------- |  | ------ | ------- | ------------------------------- | - | ------ |  | ----------------------------- | ------- | - | - | ---- | 
|                                       |  | 2007   |         | 2006                            |  
|                                       |  |        |         |                                 |  
|                                       |  | Shares |         | Weighted
Average
Exercise Price |   | Shares |  | WeightedAverageExercise Price |        
|                                       |  |        |         |                                 |   |        |  |                               |        
|                                       |  |        |         |                                 |   |        |  |                               |         |   |   |      | 
|Incentive Agreements                   |  |        |         |                                 |   |        |  |                               |         |   |   |      | 
|                                       |  |        |         |                                 |   |        |  |                               |         |   |   |      | 
|Options outstanding, beginning of year |  |        | 377,813 |                                 | $ | 6.69   |  |                               | 461,050 |   | $ | 6.52 | 
|                                       |  |        |         |                                 |   |        |  |                               |         |   |   |      | 
|Options granted                        |  |        |        |                                 | $ |       |  |                               |        |   | $ |     | 
|Options exercised                      |  |        | (38,180 | )                               | $ | 5.45   |  |                               | (76,337 | ) | $ | 5.74 | 
|Options cancelled                      |  |        |        |                                 | $ |       |  |                               | (6,900  | ) | $ | 7.28 | 
|                                       |  |        |         |                                 |   |        |  |                               |         |   |   |      | 
|                                       |  |        |         |                                 |   |        |  |                               |         |   |   |      | 
|Options outstanding, end of year       |  |        | 339,633 |                                 | $ | 6.80   |  |                               | 377,813 |   | $ | 6.69 | 
|                                       |  |        |         |                                 |   |        |  |                               |         |   |   |      | 
|                                       |  |        |         |                                 |   |        |  |                               |         |   |   |      | 
|Options exercisable, end of year       |  |        | 285,913 |                                 | $ | 6.61   |  |                               | 248,040 |   | $ | 6.32 | 
|                                       |  |        |         |                                 |   |        |  |                               |         |   |   |      | 
|                                       |  |        |         |                                 |   |        |  |                               |         |   |   |      | 
|Nonstatutory Agreements                |  |        |         |                                 |   |        |  |                               |         |   |   |      | 
|                                       |  |        |         |                                 |   |        |  |                               |         |   |   |      | 
|Options outstanding, beginning of year |  |        | 290,686 |                                 | $ | 7.50   |  |                               | 379,800 |   | $ | 7.50 | 
|                                       |  |        |         |                                 |   |        |  |                               |         |   |   |      | 
|Options granted                        |  |        | 30,000  |                                 | $ | 19.70  |  |                               |        |   | $ |     | 
|Options exercised                      |  |        | (3,550  | )                               | $ | 7.50   |  |                               | (59,114 | ) | $ | 7.50 | 
|Options cancelled                      |  |        |        |                                 | $ |       |  |                               | (30,000 | ) | $ | 7.50 | 
|                                       |  |        |         |                                 |   |        |  |                               |         |   |   |      | 
|                                       |  |        |         |                                 |   |        |  |                               |         |   |   |      | 
|Options outstanding, end of year       |  |        | 317,136 |                                 | $ | 8.65   |  |                               | 290,686 |   | $ | 7.50 | 
|                                       |  |        |         |                                 |   |        |  |                               |         |   |   |      | 
|                                       |  |        |         |                                 |   |        |  |                               |         |   |   |      | 
|Options exercisable, end of year       |  |        | 229,709 |                                 | $ | 7.50   |  |                               | 174,412 |   | $ | 7.50 | 
|                                       |  |        |         |                                 |   |        |  |                               |         |   |   |      | 

The aggregate
intrinsic value is calculated as the difference between the exercise price of
the underlying awards and the quoted price of the Companys common stock for options
that were in-the-money at December 31, 2007. The intrinsic value of options
outstanding and exercisable as of December 31, 2007 relating to the above stock
option plans was $2,730,000. The intrinsic value of options vested or expected
to vest as of December 31, 2007 relating to the above stock option plans was
$3,065,000. The weighted average remaining contractual term for options
outstanding and exercisable was 5.5 years. During the years ended December 31,
2007, 2006 and 2005, the aggregate intrinsic value of options exercised was
$569,000, $1,011,000, and $1,166,000, respectively.

The cash
received from options exercised for the years ended December 31, 2007, 2006 and
2005 was $235,000, $880,000 and $330,000, respectively. The actual tax benefit
realized for the tax deductions from options exercised was $223,000, $736,000
and $79,000 for the years ended December 31, 2007, 2006 and 2005, respectively.

28

---



PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

REGULATORY CAPITAL

The Company and the Bank are
subject to certain regulatory capital requirements administered by the Board of
Governors of the Federal Reserve System and the Federal Deposit Insurance
Corporation (FDIC). Failure to meet these minimum capital requirements can
initiate certain mandatory, and possibly additional discretionary, actions by
regulators that, if undertaken, could have a direct material effect on the
Companys consolidated financial statements. Under capital adequacy guidelines
and the regulatory framework for prompt corrective action, the Bank must meet
specific capital guidelines that involve quantitative measures of its assets,
liabilities and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Companys and the Banks capital amounts and
classification are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.

Quantitative
measures established by regulation to ensure capital adequacy require the
Company and the Bank to maintain minimum amounts and ratios of total and Tier 1
capital to risk-weighted assets and of Tier 1 capital to average assets as set
forth on the following table. Each of these components is defined in the regulations.
Management believes that the Company and the Bank met all their capital
adequacy requirements as of December 31, 2007 and 2006.

In
addition, the most recent notification from the FDIC categorized the Bank as
well capitalized under the regulatory framework for prompt correction action.
To be considered well capitalized, the Bank must maintain minimum total
risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth below.
There are no conditions or events since December 31, 2007 that management
believes have changed the Banks category.

Table 23: Regulatory Capital

|                                         |  |        |        |                               |  |                                                                  |   |                        |        |                |  |               |   |   |        |  |  |      |  
|---------------------------------------- |  | ------ | ------ | ----------------------------- |  | ---------------------------------------------------------------- | - | ---------------------- | ------ | -------------- |  | ------------- | - | - | ------ |  |  | ---- | -
|                                         |  | Actual |        | For Capital
Adequacy Purposes |  | To Be Well Capitalized
Under Prompt Corrective
Action Provisions |  
|                                         |  |        |        |                               |  |                                                                  |  
|                                         |  | Amount |        | Ratio                         |  | Minimum
Amount                                                   |   | Minimum
Ratio          |        | Minimum
Amount |  | Minimum
Ratio |  
|                                         |  |        |        |                               |  |                                                                  |   |                        |        |                |  |               |  
|                                         |  |        |        |                               |  |                                                                  |   | (Dollars in thousands) |        |                |  |               |   |   |       
|                                         |  |        |        |                               |  |                                                                  |   |                        |        |                |  |               |   |   |        |  |  |      |  
|December 31, 2007                        |  |        |        |                               |  |                                                                  |   |                        |        |                |  |               |   |   |        |  |  |      |  
|Company:                                 |  |        |        |                               |  |                                                                  |   |                        |        |                |  |               |   |   |        |  |  |      |  
|Total capital (to risk-weighted assets)  |  | $      | 46,285 |                               |  | 12.6                                                             | % | $                      | 29,433 |                |  | 8.0           | % |   | N/A    |  |  | N/A  |  
|Tier 1 capital (to risk weighted assets) |  | $      | 42,018 |                               |  | 11.4                                                             | % | $                      | 14,717 |                |  | 4.0           | % |   | N/A    |  |  | N/A  |  
|Tier 1 capital (to average assets)       |  | $      | 42,018 |                               |  | 10.2                                                             | % | $                      | 16,524 |                |  | 4.0           | % |   | N/A    |  |  | N/A  |  
|                                         |  |        |        |                               |  |                                                                  |   |                        |        |                |  |               |   |   |        |  |  |      |  
|Bank:                                    |  |        |        |                               |  |                                                                  |   |                        |        |                |  |               |   |   |        |  |  |      |  
|Total capital (to risk-weighted assets)  |  | $      | 44,368 |                               |  | 12.1                                                             | % | $                      | 29,256 |                |  | 8.0           | % | $ | 36,570 |  |  | 10.0 | %
|Tier 1 capital (to risk-weighted assets) |  | $      | 40,198 |                               |  | 11.0                                                             | % | $                      | 14,628 |                |  | 4.0           | % | $ | 21,942 |  |  | 6.0  | %
|Tier 1 capital (to average assets)       |  | $      | 40,198 |                               |  | 9.8                                                              | % | $                      | 16,428 |                |  | 4.0           | % | $ | 20,535 |  |  | 5.0  | %
|                                         |  |        |        |                               |  |                                                                  |   |                        |        |                |  |               |   |   |        |  |  |      |  
|                                         |  |        |        |                               |  |                                                                  |   |                        |        |                |  |               |   |   |        |  |  |      |  
|December 31, 2006                        |  |        |        |                               |  |                                                                  |   |                        |        |                |  |               |   |   |        |  |  |      |  
|Company:                                 |  |        |        |                               |  |                                                                  |   |                        |        |                |  |               |   |   |        |  |  |      |  
|Total capital (to risk-weighted assets)  |  | $      | 39,427 |                               |  | 11.8                                                             | % | $                      | 26,654 |                |  | 8.0           | % |   | N/A    |  |  | N/A  |  
|Tier 1 capital (to risk-weighted assets) |  | $      | 35,499 |                               |  | 10.6                                                             | % | $                      | 13,327 |                |  | 4.0           | % |   | N/A    |  |  | N/A  |  
|Tier 1 capital (to average assets)       |  | $      | 35,499 |                               |  | 10.1                                                             | % | $                      | 13,961 |                |  | 4.0           | % |   | N/A    |  |  | N/A  |  
|                                         |  |        |        |                               |  |                                                                  |   |                        |        |                |  |               |   |   |        |  |  |      |  
|Bank:                                    |  |        |        |                               |  |                                                                  |   |                        |        |                |  |               |   |   |        |  |  |      |  
|Total capital (to risk-weighted assets)  |  | $      | 37,141 |                               |  | 11.2                                                             | % | $                      | 27,922 |                |  | 8.0           | % | $ | 33,317 |  |  | 10.0 | %
|Tier 1 capital (to risk-weighted assets) |  | $      | 34,141 |                               |  | 10.3                                                             | % | $                      | 13,327 |                |  | 4.0           | % | $ | 19,990 |  |  | 6.0  | %
|Tier 1 capital (to average assets)       |  | $      | 34,141 |                               |  | 9.7                                                              | % | $                      | 13,961 |                |  | 4.0           | % | $ | 17,451 |  |  | 5.0  | %

29

---



PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)

|                       
|-----------------------
|NOTE 12. OTHER EXPENSES
|                       

Other expenses
consisted of the following:

|                                   |  |                         |       |      |   |       |  |   |       | 
|---------------------------------- |  | ----------------------- | ----- | ---- | - | ----- |  | - | ----- | 
|Table 24:
  Other Expenses         |  | Year
Ended December 31, |      
|                                   |  |                         |      
|                                   |  | (In
thousands)          |      
|                                   |  | 2007                    |       | 2006 |   | 2005  | 
|                                   |  |                         |       |      |   |       | 
|Professional
  fees                |  | $                       | 294   |      | $ | 349   |  | $ | 397   | 
|Appraisal
  fees                   |  |                         | 266   |      |   | 337   |  |   | 255   | 
|Directors
  fees                   |  |                         | 290   |      |   | 274   |  |   | 259   | 
|Postage,
  stationery and supplies |  |                         | 212   |      |   | 184   |  |   | 196   | 
|Telephone                          |  |                         | 251   |      |   | 210   |  |   | 190   | 
|Data
  processing                  |  |                         | 328   |      |   | 286   |  |   | 243   | 
|Advertising
  and promotion        |  |                         | 564   |      |   | 365   |  |   | 127   | 
|Other
  operating expenses         |  |                         | 1,568 |      |   | 1,224 |  |   | 1,245 | 
|                                   |  |                         |       |      |   |       |  |   |       | 
|Total other
  expense              |  | $                       | 3,773 |      | $ | 3,229 |  | $ | 2,912 | 
|                                   |  |                         |       |      |   |       |  |   |       | 

|                                 
|---------------------------------
|NOTE 13. LOANS TO RELATED PARTIES
|                                 

During the
normal course of business, the Company enters into loans with related parties,
including executive officers and directors. These loans are made with
substantially the same terms, including rates and collateral, as loans to
unrelated parties. The following is a summary of the aggregate activity
involving related party borrowers (in thousands):

|                                                                |  |   |            |  
|--------------------------------------------------------------- |  | - | ---------- | -
|Table 25:
  Related Party Loans                                 |  |   |            |  
|                                                                |  |   |            |  
|Balance,
  January 1, 2007                                      |  | $ | 6,927,000  |  
|Disbursements                                                   |  |   | 2,648,000  |  
|Amounts repaid                                                  |  |   | (4,903,000 | )
|                                                                |  |   |            |  
|Balance,
  December 31, 2007                                    |  | $ | 4,672,000  |  
|                                                                |  |   |            |  
|                                                                |  |   |            |  
|Undisbursed
  commitments to related parties, December 31, 2007 |  | $ | 5,187,000  |  
|                                                                |  |   |            |  

|                               
|-------------------------------
|NOTE 14. EMPLOYEE BENEFIT PLANS
|                               

The 401(k)
Savings Plan established by the Bank in 1990 was converted into a Company plan
in 2002. Under the provisions of the plan, the Company matches one-half of the
employees contributions up to a maximum of three percent of an employees
annual salary. All employees who are at least 21 years of age and have
completed one year of service are eligible under the plan. The Companys
contributions vest at a rate of 20% after one year of service and an additional
20% for each year thereafter. Contributions to the plan totaled $18,000,
$21,000 and $30,000 for the years ended December 31, 2007, 2006 and 2005,
respectively.

SALARY CONTINUATION AND RETIREMENT PLANS

The Board of
Directors approved salary continuation and retirement plans for six key
executives in 2003 and for one additional executive in 2007. Under these plans,
the executives will receive monthly payments for twenty years after retirement.
These benefits are substantially equivalent to those available under
split-dollar life insurance policies purchased by the Company on the lives of
the executives. In addition, the estimated present value of these future
benefits is accrued over the period from the effective dates of the plans until
the participants expected retirement dates based on a 7% discount rate. The
expense recognized under these plans for the years ended December 31, 2007 and
2006 totaled $231,000 and $209,000, respectively. Accrued compensation payable
under the plans totaled $1,016,000 and $785,000 at December 31, 2007 and 2006,
respectively.

30

---



PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)

In
connection with these plans, the Company purchased single premium life
insurance policies with cash surrender values totaling $8,025,000 at December
31, 2007. Income earned on these policies, net of expenses, totaled $246,000,
$208,000 and $165,000 for the years ended December 31, 2007, 2006 and 2005,
respectively. Income earned on these policies is not subject to federal or
state income tax under certain circumstances.

|                             
|-----------------------------
|NOTE 15. COMPREHENSIVE INCOME
|                             

Comprehensive
income is a more inclusive financial reporting methodology that includes
disclosure of other comprehensive income that historically has not been
recognized in the calculation of net income. The Companys only source of other
comprehensive income (loss) is unrealized gains and losses on the Companys
available-for-sale investment securities. Total comprehensive income and the
components of accumulated other comprehensive income (loss) are presented in
the consolidated statement of changes in shareholders equity.

At December 31,
2007, 2006 and 2005, the Company held securities classified as
available-for-sale which had changes in net unrealized gains or losses as
follows:

|                                                    |  |                |      |      |   |      |   |   |      |  
|--------------------------------------------------- |  | -------------- | ---- | ---- | - | ---- | - | - | ---- | -
|Table 26:
Comprehensive Income                      |  | 2007           |      | 2006 |   | 2005 |  
|                                                    |  |                |      |      |   |      |  
|                                                    |  | (In
thousands) |     
|Other
  comprehensive (loss) income:                |  |                |      |      |   |      |   |   |      |  
|Unrealized holding (losses) gains                   |  | $              | (565 | )    | $ | 78   |   | $ | (233 | )
|Tax benefit (expense) on unrealized holding
  gains |  |                | 226  |      |   | (30  | ) |   | 93   |  
|                                                    |  |                |      |      |   |      |   |   |      |  
|Total other comprehensive (loss) income             |  | $              | (339 | )    | $ | 48   |   | $ | (140 | )
|                                                    |  |                |      |      |   |      |   |   |      |  

|                                                              
|--------------------------------------------------------------
|NOTE 16. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
|                                                              

Disclosures
include estimated fair values for financial instruments for which it is
practicable to estimate fair value. These estimates are made at a specific
point in time based on relevant market data and information about the financial
instruments. These estimates do not reflect any premium or discount that could
result from offering the Companys entire holdings of a particular financial
instrument for sale at one time, nor do they attempt to estimate the value of
anticipated future business related to the instruments. In addition, the tax
ramifications related to the realization of unrealized gains and losses can
have a significant effect on fair value estimates and have not been considered
in any of these estimates.

Because
no market exists for a significant portion of the Companys financial
instruments, fair value estimates are based on judgments regarding current
economic conditions, risk characteristics of various financial instruments and
other factors. These estimates are subjective in nature and involve
uncertainties and matters of significant judgment and therefore cannot be
determined with precision. Changes in assumptions could significantly affect
the fair values presented.

The
following methods and assumptions were used by management to estimate the fair
value of the Companys financial instruments at December 31, 2007 and 2006:

CASH AND CASH EQUIVALENTS

For cash and
cash equivalents, the carrying amount is estimated to be fair value.

INTEREST BEARING DEPOSITS IN OTHER BANKS

For interest
bearing deposits in other banks, the carrying amount is estimated to be fair
value.

INVESTMENT SECURITIES

For investment
securities, fair values are based on quoted market prices, where available. If
quoted market prices are not available, fair values are estimated using quoted
market prices for similar securities and indications of value provided by
brokers.

31

---



PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)

LOANS

For
variable-rate loans that reprice frequently with no significant change in
credit risk, fair values are based on carrying values. The fair values for the
remaining loans are estimated using discounted cash flow analyses, using
interest rates being offered at each reporting date for loans with similar
terms to borrowers of comparable creditworthiness adjusted for the allowance
for loan losses. The carrying amount of accrued interest receivable
approximates its fair value.

COMPANY OWNED LIFE INSURANCE

The fair
values of life insurance policies are based on current cash surrender values at
each reporting date provided by the insurers.

OTHER INVESTMENTS

Other
investments include Federal Reserve Bank Stock, Federal Home Loan Bank Stock
and Farmer Mac Home Administrative Stock. The carrying value of other
investments approximate fair value. These investments are carried at cost and
are redeemable at par with certain restrictions.

DEPOSITS

The fair
values for demand deposits are, by definition, equal to the amount payable on
demand at the reporting date represented by their carrying amount. Fair values
for fixed-rate certificates of deposit are estimated using a discounted cash
flow analysis using interest rates offered at each reporting date by the
Company for certificates with similar remaining maturities. The carrying amount
of accrued interest payable approximates its fair value.

OTHER BORROWINGS

The carrying
amount of short-term borrowings and interest payable approximates their fair
value. The fair value of long-term debt is estimated using a discounted cash
flow analysis using interest rates currently available to the Company for
similar debt instruments.

SUBORDINATED DEBENTURES

The fair value
of subordinated debentures was determined based on the current market value for
like-kind instruments of similar rates and terms.

COMMITMENTS TO FUND LOANS/STANDBY LETTERS OF
CREDIT

Off-balance-sheet
commitments to extend credit are primarily for adjustable rate loans and
letters of credit. The fair values of commitments are estimated using the fees
currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present creditworthiness of the counterparties.
The differences between the carrying value of commitments to fund loans or
standby letters of credit and their fair value are not significant and,
therefore, not included in the following table.

|                                                |  |                   |         |                   |   |                 |  |            |         |  |   |         | 
|----------------------------------------------- |  | ----------------- | ------- | ----------------- | - | --------------- |  | ---------- | ------- |  | - | ------- | 
|Table 27:
  Fair Value of Financial Instruments |  |                   |         |                   |   |                 |  |            |         |  |   |         | 
|                                                |  | December
31, 2007 |         | December
31, 2006 |  
|                                                |  |                   |         |                   |  
|                                                |  | Carrying
Amount   |         | Fair
Value        |   | Carrying
Amount |  | Fair
Value |        
|                                                |  |                   |         |                   |   |                 |  |            |        
|                                                |  | (In
  thousands)  |        
|                                                |  |                   |        
|Financial assets:                               |  |                   |         |                   |   |                 |  |            |         |  |   |         | 
|Cash and due from banks                         |  | $                 | 13,794  |                   | $ | 13,794          |  | $          | 18,985  |  | $ | 18,985  | 
|Federal funds sold                              |  |                   | 31,880  |                   |   | 31,880          |  |            | 31,630  |  |   | 31,630  | 
|Interest bearing deposits in other banks        |  |                   | 3,000   |                   |   | 3,000           |  |            |        |  |   |        | 
|Investment securities                           |  |                   | 41,352  |                   |   | 41,352          |  |            | 23,107  |  |   | 23,106  | 
|Loans, net                                      |  |                   | 308,458 |                   |   | 306,198         |  |            | 287,318 |  |   | 287,012 | 
|Company owned life insurance                    |  |                   | 8,025   |                   |   | 8,025           |  |            | 6,079   |  |   | 6,079   | 
|Accrued interest receivable                     |  |                   | 8,002   |                   |   | 8,002           |  |            | 6,201   |  |   | 6,201   | 
|Other investments                               |  |                   | 2,294   |                   |   | 2,294           |  |            | 1,409   |  |   | 1,409   | 
|                                                |  |                   |         |                   |   |                 |  |            |         |  |   |         | 
|Financial liabilities:                          |  |                   |         |                   |   |                 |  |            |         |  |   |         | 
|Deposits                                        |  | $                 | 341,821 |                   | $ | 343,373         |  | $          | 340,996 |  | $ | 340,756 | 
|Other borrowings                                |  |                   | 40,000  |                   |   | 40,019          |  |            | 4,900   |  |   | 4,900   | 
|Subordinated debentures                         |  |                   | 8,764   |                   |   | 8,630           |  |            | 8,764   |  |   | 8,604   | 
|Accrued interest payable                        |  |                   | 6,453   |                   |   | 6,453           |  |            | 3,033   |  |   | 3,033   | 

32

---



PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)

|                                                     
|-----------------------------------------------------
|NOTE 17. PARENT ONLY CONDENSED FINANCIAL
  STATEMENTS
|                                                     

CONDENSED BALANCE SHEET

December 31, 2007 and 2006(In thousands)

|                                                         |  |      |        |      |   |        |  
|-------------------------------------------------------- |  | ---- | ------ | ---- | - | ------ | -
|Table 28:
  Condensed Balance Sheet                      |  | 2007 |        | 2006 |  
|                                                         |  |      |        |      |  
|                                                         |  |      |        |      |   |        |  
|ASSETS                                                   |  |      |        |      |   |        |  
|                                                         |  |      |        |      |   |        |  
|Cash and
  cash equivalents                              |  | $    |       |      | $ | 614    |  
|Investment
  in bank subsidiary                          |  |      | 40,621 |      |   | 35,274 |  
|Investment
  in Pacific State Statutory Trust II and III |  |      | 264    |      |   | 264    |  
|Other assets                                             |  |      | 1,976  |      |   | 1,671  |  
|                                                         |  |      |        |      |   |        |  
|Total assets                                             |  | $    | 42,861 |      | $ | 37,823 |  
|                                                         |  |      |        |      |   |        |  
|                                                         |  |      |        |      |   |        |  
|LIABILITIES AND
  SHAREHOLDERS EQUITY                   |  |      |        |      |   |        |  
|                                                         |  |      |        |      |   |        |  
|Liabilities:                                             |  |      |        |      |   |        |  
|Subordinated debentures                                  |  | $    | 8,764  |      | $ | 8,764  |  
|Other liabilities                                        |  |      | 61     |      |   |       |  
|                                                         |  |      |        |      |   |        |  
|Total liabilities                                        |  |      | 8,825  |      |   | 8,764  |  
|                                                         |  |      |        |      |   |        |  
|                                                         |  |      |        |      |   |        |  
|Shareholders
  equity:                                  |  |      |        |      |   |        |  
|Common stock                                             |  |      | 10,418 |      |   | 9,651  |  
|Retained earnings                                        |  |      | 24,004 |      |   | 19,455 |  
|Accumulated other comprehensive loss, net
  of taxes     |  |      | (386   | )    |   | (47    | )
|                                                         |  |      |        |      |   |        |  
|Total shareholders equity                               |  |      | 34,036 |      |   | 29,059 |  
|                                                         |  |      |        |      |   |        |  
|                                                         |  |      |        |      |   |        |  
|Total liabilities and shareholders
equity               |  | $    | 42,861 |      | $ | 37,823 |  
|                                                         |  |      |        |      |   |        |  

33

---



PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(CONTINUED)

CONDENSED STATEMENT OF INCOME
For the Years Ended December 31, 2007, 2006 and 2005(In thousands)

|                                                          |  |      |        |      |   |       |   |   |       |  
|--------------------------------------------------------- |  | ---- | ------ | ---- | - | ----- | - | - | ----- | -
|Table 29: Condensed Income Statement                      |  | 2007 |        | 2006 |   | 2005  |  
|                                                          |  |      |        |      |   |       |  
|Income:                                                   |  |      |        |      |   |       |   |   |       |  
|Dividends declared by bank
subsidiary                     |  | $    |       |      | $ | 250   |   | $ | 550   |  
|Interest                                                  |  |      | 21     |      |   | 12    |   |   | 12    |  
|                                                          |  |      |        |      |   |       |   |   |       |  
|Total income                                              |  |      | 21     |      |   | 262   |   |   | 562   |  
|                                                          |  |      |        |      |   |       |   |   |       |  
|                                                          |  |      |        |      |   |       |   |   |       |  
|Expenses:                                                 |  |      |        |      |   |       |   |   |       |  
|Interest on subordinated
debentures                       |  |      | 702    |      |   | 710   |   |   | 527   |  
|Salaries and employee
benefits                            |  |      | 95     |      |   | 92    |   |   | 70    |  
|Professional                                              |  |      | 102    |      |   | 78    |   |   | 76    |  
|Other expenses                                            |  |      | 148    |      |   | 67    |   |   | 99    |  
|                                                          |  |      |        |      |   |       |   |   |       |  
|Total expenses                                            |  |      | 1,047  |      |   | 947   |   |   | 772   |  
|                                                          |  |      |        |      |   |       |   |   |       |  
|Loss before
 equity in undistributed income of subsidiary |  |      | (1,026 | )    |   | (685  | ) |   | (210  | )
|                                                          |  |      |        |      |   |       |   |   |       |  
|Equity in
 undistributed income of subsidiary             |  |      | 5,153  |      |   | 5,843 |   |   | 4,190 |  
|                                                          |  |      |        |      |   |       |   |   |       |  
|Income before income tax
benefit                          |  |      | 4,127  |      |   | 5,158 |   |   | 3,980 |  
|Income tax benefit                                        |  |      | (422   | )    |   | (385  | ) |   | (306  | )
|                                                          |  |      |        |      |   |       |   |   |       |  
|Net income                                                |  | $    | 4,549  |      | $ | 5,543 |   | $ | 4,286 |  
|                                                          |  |      |        |      |   |       |   |   |       |  

34

---



PACIFIC STATE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(CONTINUED)

CONDENSED STATEMENT OF CASH FLOWS

For the Years Ended December 31, 2007, 2006
and 2005(In thousands)

|                                                                               |  |      |        |      |   |        |   |   |        |  
|------------------------------------------------------------------------------ |  | ---- | ------ | ---- | - | ------ | - | - | ------ | -
|Table 30: Condensed Cash Flow                                                  |  | 2007 |        | 2006 |   | 2005   |  
|                                                                               |  |      |        |      |   |        |  
|                                                                               |  |      |        |      |   |        |  
|Cash flows
 from operating activities:                                         |  |      |        |      |   |        |   |   |        |  
|Net income                                                                     |  | $    | 4,549  |      | $ | 5,543  |   | $ | 4,286  |  
|Adjustments to reconcile net
income to net
 cash used in operating activities: |  |      |        |      |   |        |   |   |        |  
|Undistributed net income of
subsidiary                                         |  |      | (5,376 | )    |   | (5,843 | ) |   | (4,190 | )
|Increase in other
assets                                                       |  |      | (306   | )    |   | (1,138 | ) |   | (498   | )
|(Decrease) increase in other
liabilities                                       |  |      | 61     |      |   | (20    | ) |   |       |  
|                                                                               |  |      |        |      |   |        |   |   |        |  
|                                                                               |  |      |        |      |   |        |   |   |        |  
|Net cash used in operating
activities                                          |  |      | (1,072 | )    |   | (1,458 | ) |   | (402   | )
|                                                                               |  |      |        |      |   |        |   |   |        |  
|                                                                               |  |      |        |      |   |        |   |   |        |  
|Cash flows
 from investing activities:                                         |  |      |        |      |   |        |   |   |        |  
|Proceeds from matured and called
 available-for-sale investment securities     |  |      |       |      |   | 204    |   |   |       |  
|Proceeds from the retirement of
Pacific
 State Statutory Trust I               |  |      | 155    |      |   |       |   |   |       |  
|Investment in bank
subsidiary                                                  |  |      |       |      |   |       |   |   |       |  
|Investment in Pacific State
Statutory Trust
 III                               |  |      | (155   | )    |   |       |   |   |       |  
|                                                                               |  |      |        |      |   |        |   |   |        |  
|                                                                               |  |      |        |      |   |        |   |   |        |  
|Net cash provided by (used
in) investing
 activities                           |  |      |       |      |   | 204    |   |   |       |  
|                                                                               |  |      |        |      |   |        |   |   |        |  
|                                                                               |  |      |        |      |   |        |  
|Cash flows
 from financing activities:                                         |  |      |        |      |   |        |   |   |        |  
|Proceeds from issuance of junior
 subordinated debentures                      |  |      | 5,000  |      |   |        |   |   |       |  
|Retirement of junior subordinated
 debentures                                  |  |      | (5,000 | )    |   |       |   |   |       |  
|Stock options exercised and
related tax
 benefit                               |  |      | 458    |      |   | 1,616  |   |   | 409    |  
|Proceeds from the issuance of
common stock                                     |  |      |       |      |   | 250    |   |   |       |  
|Repurchase of common
stock                                                     |  |      |       |      |   |       |   |   | (12    | )
|                                                                               |  |      |        |      |   |        |   |   |        |  
|                                                                               |  |      |        |      |   |        |   |   |        |  
|Net cash provided by financing
activities                                      |  |      | 458    |      |   | 1,866  |   |   | 397    |  
|                                                                               |  |      |        |      |   |        |   |   |        |  
|                                                                               |  |      |        |      |   |        |  
|Increase
 (decrease) in cash and cash equivalents                              |  |      | (639   | )    |   | 612    |   |   | (5     | )
|                                                                               |  |      |        |      |   |        |  
|Cash and
 cash equivalents at beginning of year                                |  |      | 614    |      |   | 2      |   |   | 7      |  
|                                                                               |  |      |        |      |   |        |   |   |        |  
|                                                                               |  |      |        |      |   |        |   |   |        |  
|Cash and
 cash equivalents at end of year                                      |  | $    |       |      | $ | 614    |   | $ | 2      |  
|                                                                               |  |      |        |      |   |        |   |   |        |  
|                                                                               |  |      |        |      |   |        |  
|Non-cash
 investing activities:                                                |  |      |        |      |   |        |   |   |        |  
|Net change in unrealized loss on
available-for-sale
 investment securities     |  | $    | (565   | )    | $ | 78     |   | $ | (232   | )

35

---



FORWARD LOOKING STATMENTS

Certain
statements discussed or incorporated by reference in this Annual Report
including, but not limited to, information concerning possible or assumed future
results of operations of the Company set forth in the Managements Discussion
and Analysis of Financial Condition and Results of Operation, are
forward-looking statements within the meaning of the Securities Exchange Act of
1934 (the Exchange Act). Forward-looking statements include statements in
which words such as expect, anticipate, intend, plan,
believe,
estimate, consider or variants or similar expressions are used. The
Companys actual future results and shareholder values may differ materially
from those anticipated and expressed in these forward-looking statements, which
are based on managements beliefs and assumptions and on information currently
available to management, and are subject to risks and uncertainties that could
cause actual results to differ materially from those projected. Such risks and
uncertainties include, among others, (1) competitive pressures in the banking
industry; (2) changes in the interest rate environment; (3) general economic
conditions, either nationally or regionally; (4) changes in the regulatory
environment; (5) changes in business conditions and inflation; and (6) changes
in securities markets. Many of these factors are beyond the Companys ability
to control or predict. Investors are cautioned not to put undue reliance on any
forward-looking statements. In addition, the Company does not have any
intention or obligation to update forward-looking statements contained in this
Annual Report, even if new information, future events or other circumstances
have made them incorrect or misleading. Except as specifically noted herein all
references to the Company refer to Pacific State Bancorp, a California
corporation.

36

---



|                               
|-------------------------------
|GENERAL DESCRIPTION OF BUSINESS
|                               

Pacific State
Bancorp (the Company) is a holding company with one bank subsidiary, Pacific
State Bank, (the Bank), and two unconsolidated subsidiary grantor trusts,
Pacific State Statutory Trusts II and III. Pacific State Bancorp commenced
operations on June 24, 2002 after acquiring all of the outstanding shares of
Pacific State Bank. The Bank is a California state chartered bank formed
November 2, 1987. The Bank is a member of the Federal Reserve System. The
Banks primary source of revenue is interest on loans to customers who are
predominantly small to middle-market businesses and middle-income individuals.
Pacific State Statutory Trusts II and III are unconsolidated, wholly owned
statutory business trusts formed in March 2004 and June 2007, respectively for
the exclusive purpose of issuing and selling trust preferred securities.

The
Bank conducts a general commercial banking business, primarily in the five
county region that comprises Alameda, Calaveras, San Joaquin, Stanislaus and
Tuolumne counties. The Bank offers commercial banking services to residents and
employers of businesses in the Banks service area, including professional
firms and small to medium sized retail and wholesale businesses and
manufacturers. The Company as of March 15, 2008 had 84 employees, including 26
officers. The Bank does not engage in any non-bank lines of business. The
business of the Bank is not to any significant degree seasonal in nature. The
Bank has no operations outside California and has no material amount of loans
or deposits concentrated among any one or few persons, groups or industries.
The Bank operates nine branches with its Administrative Office and one branch
located at 1899 W. March Lane, in Stockton, California; additional branches are
located in downtown Stockton and in the communities of Angels Camp, Arnold,
Groveland, Lodi, Modesto, Tracy and Hayward, California.

Pacific
State Bancorp common stock trades on the NASDAQ Global Market under the symbol
of PSBC.

BUSINESS PLAN

The focus of
the Companys business plan is to attract Business Relationship small, medium
and large accounts, but not to the exclusion of any other business which the
Company can reasonably and profitably attract. In order to provide a level of
service to attract such customers, the Company has structured its specific
services and charges on a basis which management believes to be profitable,
taking into consideration other aspects of the account relationship. The
Company offers a full range of banking services to its customers intended to
attract the following specific types of accounts: relatively large consumer
accounts; professional group and association accounts, including the accounts
of groups or firms of physicians, dentists, attorneys and accountants; and
accounts of small to medium-sized businesses engaged in retail, wholesale,
light industrial, manufacturing, agricultural and service activities.

TRUST SUBSIDIARIES

The Company
during 2002, 2004, and 2007 established three subsidiary grantor trusts.
Pacific State Statutory Trusts I, II and III (the Trusts). The Trusts were
established for the sole purpose of issuing capital securities (Capital
Securities) pursuant to declarations of trust (the Declarations). The
proceeds from the sale of the Capital Securities were loaned to the Company as
subordinated debentures (the Debentures) issued to the Trusts pursuant to
indentures (the Indentures). Interest payments on the Debentures will flow
through the Trusts to the Pooling Vehicles, which are the holders of the
Capital Securities and similar securities issued by other financial
institutions. Payments of distributions by the Trusts to the Pooling Vehicle
are guaranteed by the Company. See Note 8 to the Companys consolidated
financial statements included with this report.

Proceeds
from the issuance of the 2002 subordinated debentures were used to provide the
Bank with an additional $4.5 million in capital in order to support the
continued growth of the Bank. The remaining $500,000 was placed in the Company
for general corporate purposes. Proceeds from the issuance of the 2004
subordinated debentures were used to provide the Bank with an additional $3.5
million in capital in order to support the continued growth of the Bank.
Proceeds from the issuance of the 2007 subordinated debentures were used to
retire the 2002 subordinated debenture issuance. Trust I was dissolved in 2007
following the retirement of the 2002 subordinated debentures. By refinancing
the 2002 subordinated debenture issuance with the 2007 issuance, the Company
was able to reduce interest expense related to the Trusts.

37

---



PRODUCT LINES AND SERVICES

The Bank
currently offers the following general banking services at all of its branches:
commercial, construction, agricultural and real estate loans and personal
credit lines, interest on checking, U.S. Savings bond services, domestic and
foreign drafts, banking by appointment, automatic transfer of funds between
savings and checking accounts, business courier services, checking and savings
accounts for personal and business purposes, domestic letters of credit, a
depository for MasterCard and Visa drafts, federal depository services, cash
management assistance, wire and telephone transfers, Individual Retirement
Accounts, time certificates of deposit, courier service for non-cash deposits,
Visa and MasterCard, revolving lines of credit to consumers secured by deeds of
trust on private residences, unsecured overdraft protection credit lines
attached to checking accounts, ATM cards and MasterMoney debit cards via the
Star, Cirrus, Plus, MasterCard and Visa networks.

The
Bank is not authorized to offer trust services. The Federal Reserve Bank of San
Francisco is the Companys primary correspondent relationship. The Bank
currently also has correspondent relationships with City National Bank in
Beverly Hills, California, First Tennessee Bank in Memphis, Tennessee, U. S.
Bank, Minneapolis, Minnesota, Wells Fargo Bank, San Francisco, California and
Pacific Coast Bankers Bank, San Francisco, California.

The
Bank recognizes that, in order to be competitive, it must attract a certain
number of consumer accounts. Individual Retirement Accounts, Visa and
MasterCard, revolving lines of credit to consumers secured by deeds of trust on
private residences, and unsecured overdraft protection credit lines attached to
checking accounts currently offered by the Bank are designed to appeal
particularly to consumers. Moreover, participation in large-scale ATM networks
assists the Company in competing for consumer accounts.

The Bank is an approved
Small Business Administration and 504 lender, FSA, USDA Business and Industry,
USDA Part-time Farmer Program and FHA and VA lender. The Bank is a national
leader in the underwriting of U.S. Department of Agriculture business and
industry loans, as well as a Preferred Lender for this program.

|                                                                                        
|----------------------------------------------------------------------------------------
|MANAGEMENTS DISCUSSION AND ANALYSIS OF
 FINANCIAL CONDITION AND 
 RESULTS OF OPERATIONS
|                                                                                        

CRITICAL ACCOUNTING POLICIES

General

Pacific State
Bancorps consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America
(GAAP). The financial information contained within our consolidated financial
statements is, to a significant extent, financial information that is based on
measures of the financial effects of transactions and events that have already
occurred. A variety of factors could affect the ultimate value that is obtained
either when earning income, recognizing an expense, recovering an asset or
relieving a liability. We use historical loss factors as one factor in
determining the inherent loss that may be present in our loan portfolio. Actual
losses could differ significantly from the historical factors that we use.

Effective
January 1, 2006, the Company adopted Statement of Financial Accounting Standard
(SFAS) No. 123(R), Share Based Payment; see information under the header
Share Based Compensation in Note 2 to the consolidated financial statements
included with this report. Other estimates that we use are related to the
assumptions and estimates related to share based compensation, expected useful
lives of our depreciable assets and the determination whether any impairment
exists related to our investments and intangible and other long-lived assets.
In addition, GAAP itself may change from one previously acceptable method to
another method. Although the economics of our transactions would be the same,
the timing of events that would impact our transactions could change.

A
critical accounting estimate is one that requires a company to make assumptions
about matters that are highly uncertain at the time the accounting estimate is
made. If different estimates that the company reasonably could have used for
the accounting estimate in the current period were made, or if changes in the
accounting estimate that are reasonably likely to occur from period to period
occurred, they could have a material impact on the presentation of the
companys financial condition, changes in financial condition or results of
operations.

Allowance for Loan
Losses

The allowance
for loan losses is an estimate of the losses that may be sustained in our loan
portfolio. The allowance is based on two basic principles of accounting. (1)
Statement of Financial Accountings Standards (SFAS) No. 5 Accounting for
Contingencies, which requires that losses be accrued when they are probable of
occurring and estimable and (2) SFAS No. 114, Accounting by Creditors for
Impairment of a Loan, which requires that losses on impaired loans be accrued
and measured based on the differences between the value of collateral, present
value of future cash flows or values that are observable in the secondary
market and the loan balance.

38

---



Share Based
Compensation

Effective
January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123 (R), Share-Based Payment (SFAS 123 (R)). Under SFAS 123(R),
compensation cost recognized for all awards that vest subsequent to the date of
adoption based are on the grant-date fair value estimated in accordance with
SFAS No. 123, Accounting for Stock-Based Compensation and SFAS 123(R). The
grant-date fair value is estimated using the Black-Scholes option-pricing
formula, which involves making estimates of the assumptions used, including the
expected term of the option, expected volatility over the option term, expected
dividend yield over the option term and risk-free interest rate. In addition,
when determining the compensation expense to amortize over the vesting period,
management makes estimates about the expected forfeiture rate of options.

RESULTS OF OPERATIONS

Year Ended December
31, 2007 Compared to Year Ended December 31, 2006

Net income for the year ended December 31, 2007, was $4,549,000
representing a decrease of $994,000 or 17.93% over net income of $5,543,000 for
the year ended December 31, 2006. The primary cause of the
decrease in net income was the increase in the provision for loan losses of
$1,065,000 or $627,000 after the recorded tax effect, over 2006 levels. In
addition to the increase in the provision for loan losses, noninterest expense
increased by $637,000, or $375,000 after the recorded tax effect, over 2006
levels. The increase in noninterest expense is primarily attributable to the
full year recognition of expenses in 2007 related to the opening of two new
branches in late 2006. In 2007 the Company achieved strong growth in average
earning assets, increasing by $63,105,000 or 21%. The average yield earned on
average earning assets decreased by 23 basis points or 3%. In order to fund the
growth in average earning assets, the Company increased its average interest
bearing liabilities by $60,751,000 or 25%. The average rate paid on interest
bearing liabilities increased by 78 basis points or 20%. The growth in average
earning assets increased total interest earned by $4,747,000 or 18%, while the
increase in interest bearing liabilities increased interest expense by
$4,654,000, resulting in an increase of net interest income of $93,000. A more
in depth discussion of average balances and the rates received or paid on those
balances is presented in the section titled Net Interest Income below.

Return
on average assets (ROA) decreased to 1.13% while the return on average equity
(ROE) decreased to 14.22% in 2007 compared with 1.67% and 22.91%, respectively,
in 2006. Diluted earnings per share for 2007 and 2006 were $1.14 and $1.41,
respectively, a decrease of 19.15%. The decrease in earnings per share was primarily
due to the decrease in net income of 17.93%.

The
Companys average total assets increased to $402.5 million in 2007 or 21.53%
over $331.2 million in 2006. The Companys total assets increased to $431.1
million as of December 31, 2007 or 11.46% over $386.8 million at December 31,
2006. Total gross loans increased in 2007 to $312.4 million from $289.8 million
in 2006, an increase of $22.6 million or 7.80%. Total deposits grew to $341.8
million, or 0.23%, compared to $341.0 million in 2006. Total borrowings grew to
$48.8 million, or 256.20%, compared to $13.7 million in 2006. The increases in
the balance sheet and, particularly in loans and borrowings, were attributable
to the continued growth of the bank.

Year Ended December
31, 2006 Compared to Year Ended December 31, 2005

Net income for the year ended December 31, 2006, was $5,543,000
representing an increase of $1,257,000 or 29.33% over net income of $4,286,000
for the year ended December 31, 2005. The primary contributing
factor to the increase in net income was an increase in net interest income of
$3,771,000 as a result of an increase in both the volume of average earning
assets and the rates earned on those assets, offset by the increase in average
interest bearing liabilities and the rates paid on those liabilities. Overall
the net interest margin increased 35 basis points in 2006 from 2005. This was
offset by an increase in non-interest expense of $1,260,000 and mitigated by a
slight increase in non-interest income of $102,000. The increase in
non-interest expenses was primarily due to an increase in salaries and employee
benefits of $737,000 and in other expenses of $317,000.

Return
on average assets (ROA) improved to 1.67% while the return on average equity
(ROE) decreased slightly to 22.91% in 2006 compared with 1.53% and 22.98%,
respectively, in 2005. Diluted earnings per share for 2006 and 2005 were $1.41
and $1.10, respectively, an increase of 28.18%. The increase in earnings per
share was primarily due to the increase in net income of 29.33%.

The
Companys average total assets increased to $331.2 million in 2006 or 18.16%
over $280.3 million in 2005. In 2006 average earning assets increased to $300.4
million or 18.16% over $250.1 million in 2005. Average interest bearing
liabilities increased to $241.0 million or 19.53% over $204.6 million in 2005.
The increase in average assets is the result of increase market penetration and
the opening of branches in new market areas.

39

---



The
Companys total assets increased to $386.8 million as of December 31, 2006 or
24.92% over $309.6 million at December 31, 2005. Total loans increased in 2006
to $289.8 million from $243.7 million in 2005, an increase of $46.1 million or
18.90%. Total Deposits grew to $341.0 million, or 24.86%, compared to $273.1
million in 2005. The increases in the balance sheet and, particularly in loans
and deposits, were attributable to the continued growth of the bank.

Net Interest Income

The primary
source of income for the Company is derived from net interest income. Net
interest income represents the excess of interest and fees earned on
interest-earning assets (loans, securities and federal funds sold) over the
interest paid on deposits and borrowed funds. Net interest margin is net interest
income expressed as a percentage of average earning assets.

Net
interest income increased $93 thousand or 0.54% to $17.4 million in 2007 from
$17.3 million in 2006 and $3.8 million or 27.86% in 2006 from $13.5 million in
2005. Total average earning assets increased $63.1 million or 21.01% to $363.5
million from $300.4 million in 2006. Average loan balances outstanding during
2007 increased $30.8 million or 11.45%, while average balances of investments,
federal funds sold and interest bearing deposits in banks increased by $32.3
million or 104.00%. The average yields on loans in 2007 increased by 5 basis
points. The average yield on investments, federal funds sold and interest
bearing deposits increased 14 basis points in 2007 compared to 2006. The slight
increase in yields is related to fluctuating market conditions based on
economic data, competition and the lagging effect of prior year interest rate
cuts. As a result of the change in mix of earning assets, the overall yield on
average earning assets during 2007 decreased 23 basis points to 8.59% from
8.82% for 2006.

Total
interest expense increased $4.6 million or 50.65% to $13.8 million in 2007,
from $9.2 million in 2006. Total interest expense increased $4.0 million or
76.92% to $9.2 million in 2006, from $5.2 million for 2005. In 2007 the average
balance of interest-bearing liabilities increased $60.8 million or 25.21% to
$301.8 million from $241.0 million for the year ended December 31, 2006. In
2006 the average balance of interest-bearing liabilities increased $39.4
million or 19.53% to $241.0 million from $201.6 million for the year ended
December 31, 2005. Additionally, the average rate paid on interest-bearing
liabilities increased to 4.59% from 3.81% in 2006 and 2.60% in 2005. The
increase in the average interest rate paid on interest-bearing liabilities
represents 78 basis points or 20.47% in 2007 and 121 basis points or 46.54% in
2006.

Average
interest-bearing demand deposits decreased $12.6 million or 12.05% to $92.3
million in 2006 from $104.9 million in 2005. The average rate paid on these
deposits during 2006 increased 37 basis points. Average certificates of deposit
increased $48.4 million or 62.43% to $126.0 million in 2006 from $77.6 million
in 2005. The average rate paid on certificates of deposit during 2006 increased
163 basis points. As a result of the increases in interest rates described
above and overall changes in the mix of interest-bearing deposits, the average
rate paid on all interest bearing deposits and borrowings increased 121 basis
points for 2006 to 3.81% from 2.60% for 2005.

The
Companys net interest margin (net interest income divided by average earning
assets) was 4.79% in 2007, down from 5.76% or 97 basis points in 2006. 2006 net
interest margin increased 35 basis points from 5.41% in 2005. The increase in
the volume of earning assets, coupled with the change in mix of and rates paid
on interest-bearing liabilities resulted in an increase of $93 thousand or
0.54% in net interest income for the year ended December 31, 2007 compared to
2006. For the year ended December 31, 2006 compared to 2005, the combined
effect of the increase in volume of and yield on earning assets, coupled with
the change in mix and rates paid resulted in an increase of $3.8 million or
27.86% in net interest income over 2005.

The
following table sets forth the Companys daily average balance sheet, related
interest income or expense and yield or rate paid for the periods indicated.
The yield on tax-exempt securities has not been adjusted to a tax-equivalent
yield basis. Average balances are based on daily averages.

40

---



AVERAGE BALANCES, INTEREST INCOME/EXPENSE AND
YIELDS/RATES PAID

Table 31: Net Interest Margin

|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|--------------------------------------------------- |  | --------------- | ------- | -------------------------- | - | --------------------- |  | --------------- | ---- | -------------------------- | ---------------------------- | --------------------- | - | - | ------ |  |  | ---- | -
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            | For Year
 Ended December 31, |                      
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                      
|(Dollars in thousands)                              |  | 2007            |         | 2006                       |  
|                                                    |  |                 |         |                            |  
|                                                    |  | Average
Balance |         | Interest
Income or
Expense |   | Average
Yield or
Cost |  | Average
Balance |      | Interest
Income or
Expense |                              | Average
Yield or
Cost |  
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |  
|Assets:                                             |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|Interest-earning assets:                            |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|Loans                                               |  | $               | 300,239 |                            | $ | 27,902                |  |                 | 9.29 | %                          | $                            | 269,395               |   | $ | 24,901 |  |  | 9.24 | %
|Investment securities                               |  |                 | 37,089  |                            |   | 2,033                 |  |                 | 5.48 | %                          |                              | 25,418                |   |   | 1,321  |  |  | 5.20 | %
|Federal funds sold                                  |  |                 | 25,115  |                            |   | 1,285                 |  |                 | 5.12 | %                          |                              | 5,602                 |   |   | 273    |  |  | 4.87 | %
|Interest Bearing Deposits in Banks                  |  |                 | 1,077   |                            |   | 22                    |  |                 | 2.04 | %                          |                              |                      |   |   |       |  |  | 0.00 | %
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|Total average earning assets                        |  | $               | 363,520 |                            | $ | 31,242                |  |                 | 8.59 | %                          | $                            | 300,415               |   |   | 26,495 |  |  | 8.82 | %
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|Non-earning assets:                                 |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|Cash and due from banks                             |  |                 | 15,398  |                            |   |                       |  |                 |      |                            |                              | 13,655                |   |   |        |  |  |      |  
|Bank premises and equipment                         |  |                 | 12,940  |                            |   |                       |  |                 |      |                            |                              | 10,609                |   |   |        |  |  |      |  
|Other assets                                        |  |                 | 13,322  |                            |   |                       |  |                 |      |                            |                              | 9,058                 |   |   |        |  |  |      |  
|Allowance for loan loss                             |  |                 | (2,665  | )                          |   |                       |  |                 |      |                            |                              | (2,536                | ) |   |        |  |  |      |  
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|Total average assets                                |  | $               | 402,515 |                            |   |                       |  |                 |      |                            | $                            | 331,201               |   |   |        |  |  |      |  
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|Liabilities
and Shareholders Equity:               |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |     
|Interest-bearing
 liabilities:                      |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|Deposits                                            |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|Interest-bearing Demand                             |  | $               | 81,898  |                            | $ | 2,231                 |  |                 | 2.72 | %                          | $                            | 92,280                |   | $ | 2,438  |  |  | 2.64 | %
|Savings                                             |  |                 | 5,352   |                            |   | 46                    |  |                 | 0.86 | %                          |                              | 6,359                 |   |   | 56     |  |  | 0.88 | %
|Time Deposits                                       |  |                 | 200,154 |                            |   | 10,567                |  |                 | 5.28 | %                          |                              | 125,994               |   |   | 5,608  |  |  | 4.45 | %
|Other borrowing                                     |  |                 | 14,359  |                            |   | 998                   |  |                 | 6.95 | %                          |                              | 16,379                |   |   | 1,086  |  |  | 6.63 | %
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|Total average interest-bearing liabilities          |  | $               | 301,763 |                            | $ | 13,842                |  |                 | 4.59 | %                          | $                            | 241,012               |   | $ | 9,188  |  |  | 3.81 | %
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|Noninterest-bearing liabilities:                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|Demand deposits                                     |  |                 | 64,242  |                            |   |                       |  |                 |      |                            |                              | 64,593                |   |   |        |  |  |      |  
|Other liabilities                                   |  |                 | 4,525   |                            |   |                       |  |                 |      |                            |                              | 1,405                 |   |   |        |  |  |      |  
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|Total average liabilities                           |  |                 | 370,530 |                            |   |                       |  |                 |      |                            |                              | 307,010               |   |   |        |  |  |      |  
|Shareholders
 equity:                              |  |                 | 31,986  |                            |   |                       |  |                 |      |                            |                              | 24,191                |   |   |        |  |  |      |  
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|Total average liabilities
 and shareholders equity |  | $               | 402,516 |                            |   |                       |  |                 |      |                            | $                            | 331,201               |   |   |        |  |  |      |  
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|Net interest income                                 |  |                 |         |                            | $ | 17,400                |  |                 |      |                            |                              |                       |   | $ | 17,307 |  |  |      |  
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|                                                    |  |                 |         |                            |   |                       |  |                 |      |                            |                              |                       |   |   |        |  |  |      |  
|Net interest margin                                 |  |                 |         |                            |   |                       |  |                 | 4.79 | %                          |                              |                       |   |   |        |  |  | 5.76 | %

| |    |                                                                                                                                                                                                                                                                                                                                                              
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1) | Interest income and yields
 on loans include fee income of $1,623,000, $1,868,000 and $1,680,000 for the
 years ended December 31, 2007, 2006 and 2005, respectively. The Company had
 one nonaccrual loan in the amount of $432,000 as of December 31, 2007. The
 Company did not have any nonaccrual loans for the years ended December 31,
 2006 and 2005.

41

---



|                                                   |  |                 |         |                            |   |                       |  |  |      |  
|-------------------------------------------------- |  | --------------- | ------- | -------------------------- | - | --------------------- |  |  | ---- | -
|                                                   |  |                 |        
|                                                   |  | 2005            |        
|                                                   |  |                 |        
|                                                   |  | Average
Balance |         | Interest
Income or
Expense |   | Average
Yield or
Cost | 
|                                                   |  |                 |         |                            |   |                       | 
|Assets:                                            |  |                 |         |                            |   |                       |  |  |      |  
|Interest-earning assets:                           |  |                 |         |                            |   |                       |  |  |      |  
|Loans                                              |  | $               | 215,907 |                            | $ | 17,565                |  |  | 8.14 | %
|Investment securities                              |  |                 | 19,694  |                            |   | 707                   |  |  | 3.59 | %
|Federal funds sold                                 |  |                 | 11,169  |                            |   | 354                   |  |  | 3.17 | %
|Interest Bearing Deposits in Banks                 |  |                 | 3,299   |                            |   | 156                   |  |  | 4.73 | %
|                                                   |  |                 |         |                            |   |                       |  |  |      |  
|Total average earning assets                       |  | $               | 250,069 |                            | $ | 18,782                |  |  | 7.51 | %
|                                                   |  |                 |         |                            |   |                       |  |  |      |  
|Non-earning assets:                                |  |                 |         |                            |   |                       |  |  |      |  
|Cash and due from banks                            |  |                 | 14,474  |                            |   |                       |  |  |      |  
|Bank premises and equipment                        |  |                 | 9,581   |                            |   |                       |  |  |      |  
|Other assets                                       |  |                 | 8,511   |                            |   |                       |  |  |      |  
|Allowance for loan loss                            |  |                 | (2,346  | )                          |   |                       |  |  |      |  
|                                                   |  |                 |         |                            |   |                       |  |  |      |  
|Total average assets                               |  | $               | 280,289 |                            |   |                       |  |  |      |  
|                                                   |  |                 |         |                            |   |                       |  |  |      |  
|                                                   |  |                 |         |                            |   |                       |  |  |      |  
|Liabilities
and Shareholders Equity:              |  |                 |         |                            |   |                       |  |  |      |  
|Interest-bearing
 liabilities:                     |  |                 |         |                            |   |                       |  |  |      |  
|Deposits                                           |  |                 |         |                            |   |                       |  |  |      |  
|                                                   |  |                 |         |                            |   |                       |  |  |      |  
|Interest-bearing Demand                            |  | $               | 104,922 |                            | $ | 2,384                 |  |  | 2.27 | %
|Savings                                            |  |                 | 6,307   |                            |   | 36                    |  |  | 0.57 | %
|Time Deposits                                      |  |                 | 77,567  |                            |   | 2,190                 |  |  | 2.82 | %
|Other borrowing                                    |  |                 | 12,845  |                            |   | 636                   |  |  | 4.95 | %
|                                                   |  |                 |         |                            |   |                       |  |  |      |  
|                                                   |  |                 |         |                            |   |                       |  |  |      |  
|Total average interest-bearing liabilities         |  | $               | 201,641 |                            | $ | 5,246                 |  |  | 2.60 | %
|                                                   |  |                 |         |                            |   |                       |  |  |      |  
|Noninterest-bearing liabilities:                   |  |                 |         |                            |   |                       |  |  |      |  
|Demand deposits                                    |  |                 | 59,009  |                            |   |                       |  |  |      |  
|Other liabilities                                  |  |                 | 986     |                            |   |                       |  |  |      |  
|                                                   |  |                 |         |                            |   |                       |  |  |      |  
|Total average liabilities                          |  |                 | 261,636 |                            |   |                       |  |  |      |  
|Shareholders
 equity:                             |  |                 | 18,653  |                            |   |                       |  |  |      |  
|                                                   |  |                 |         |                            |   |                       |  |  |      |  
|Total average liabilities and shareholders equity |  | $               | 280,289 |                            |   |                       |  |  |      |  
|                                                   |  |                 |         |                            |   |                       |  |  |      |  
|                                                   |  |                 |         |                            |   |                       |  |  |      |  
|                                                   |  |                 |         |                            |   |                       |  |  |      |  
|Net interest income                                |  |                 |         |                            | $ | 13,536                |  |  |      |  
|                                                   |  |                 |         |                            |   |                       |  |  |      |  
|                                                   |  |                 |         |                            |   |                       |  |  |      |  
|Net interest margin                                |  |                 |         |                            |   |                       |  |  | 5.41 | %

42

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The following
table sets forth changes in interest income and expense for each major category
of earning assets and interest-bearing liabilities, and the amount of change
attributable to volume, rates and the combination of volume and rates (mix) for
the periods indicated. The yield on tax-exempt securities has not been adjusted
to a tax-equivalent yield basis.

ANALYSIS OF CHANGES IN NET INTEREST INCOME
AND EXPENSE

|                                    |  |                                          |       |      |   |        |   |     |       |   |   |      |  
|----------------------------------- |  | ---------------------------------------- | ----- | ---- | - | ------ | - | --- | ----- | - | - | ---- | -
|Table 32: Rate/Volume Table         |  | Years ended December 31,
 2007 over 2006 |      
|                                    |  |                                          |      
|(In thousands)                      |  | Net
 Change                              |       | Rate |   | Volume |   | Mix |      
|                                    |  |                                          |       |      |   |        |   |     |      
|                                    |  |                                          |       |      |   |        |   |     |       |   |   |      |  
|                                    |  |                                          |       |      |   |        |   |     |       |   |   |      |  
|Interest
 Income:                   |  |                                          |       |      |   |        |   |     |       |   |   |      |  
|Loans and
 leases                   |  | $                                        | 3,001 |      | $ | 135    |   | $   | 2,851 |   | $ | 15   |  
|Investment
 securities              |  |                                          | 712   |      |   | 72     |   |     | 607   |   |   | 33   |  
|Federal
 funds sold                 |  |                                          | 1,012 |      |   | 14     |   |     | 951   |   |   | 47   |  
|Interest
 Bearing Deposits in Banks |  |                                          | 22    |      |   |       |   |     |      |   |   | 22   |  
|                                    |  |                                          |       |      |   |        |   |     |       |   |   |      |  
|Total interest income               |  | $                                        | 4,747 |      | $ | 220    |   | $   | 4,408 |   | $ | 118  |  
|                                    |  |                                          |       |      |   |        |   |     |       |   |   |      |  
|Interest
 Expense:                  |  |                                          |       |      |   |        |   |     |       |   |   |      |  
|Interest-bearing
 Demand            |  | $                                        | (207  | )    | $ | 76     |   | $   | (274  | ) |   | (9   | )
|Savings                             |  |                                          | (10   | )    |   | (1     | ) |     | (9    | ) |   |     |  
|Time
 Deposits                      |  |                                          | 4,959 |      |   | 1,044  |   |     | 3,301 |   |   | 614  |  
|Other
 borrowing                    |  |                                          | (88   | )    |   | 53     |   |     | (134  | ) |   | (6   | )
|Total interest expense              |  | $                                        | 4,654 |      | $ | 1,171  |   | $   | 2,884 |   | $ | 600  |  
|                                    |  |                                          |       |      |   |        |   |     |       |   |   |      |  
|Net interest
 income                |  | $                                        | 93    |      | $ | (950   | ) | $   | 1,525 |   | $ | (482 | )
|                                    |  |                                          |       |      |   |        |   |     |       |   |   |      |  

|                                    |  |                                          |       |      |   |        |   |     |       |   |   |     |  
|----------------------------------- |  | ---------------------------------------- | ----- | ---- | - | ------ | - | --- | ----- | - | - | --- | -
|Table 33: Rate/Volume Table         |  | Years ended December 31,
 2006 over 2005 |      
|                                    |  |                                          |      
|(In thousands)                      |  | Net
 Change                              |       | Rate |   | Volume |   | Mix |      
|                                    |  |                                          |       |      |   |        |   |     |      
|                                    |  |                                          |       |      |   |        |   |     |       |   |   |     |  
|                                    |  |                                          |       |      |   |        |   |     |       |   |   |     |  
|Interest
 Income:                   |  |                                          |       |      |   |        |   |     |       |   |   |     |  
|Loans and
 leases                   |  | $                                        | 7,336 |      | $ | 2,392  |   | $   | 4,351 |   | $ | 593 |  
|Investment
 securities              |  |                                          | 614   |      |   | 317    |   |     | 205   |   |   | 92  |  
|Federal
 funds sold                 |  |                                          | (81   | )    |   | 190    |   |     | (176  | ) |   | (95 | )
|Interest
 Bearing Deposits in Banks |  |                                          | (156  | )    |   | (156   | ) |     | (156  | ) |   | 156 |  
|                                    |  |                                          |       |      |   |        |   |     |       |   |   |     |  
|Total interest income               |  | $                                        | 7,713 |      | $ | 2,743  |   | $   | 4,225 |   | $ | 746 |  
|                                    |  |                                          |       |      |   |        |   |     |       |   |   |     |  
|Interest
 Expense:                  |  |                                          |       |      |   |        |   |     |       |   |   |     |  
|Interest-bearing
 Demand            |  | $                                        | 54    |      | $ | 388    |   | $   | (287  | ) | $ | (47 | )
|Savings                             |  |                                          | 20    |      |   | 20     |   |     |      |   |   |    |  
|Time
 Deposits                      |  |                                          | 3,418 |      |   | 1,263  |   |     | 1,367 |   |   | 788 |  
|Other
 borrowing                    |  |                                          | 450   |      |   | 216    |   |     | 175   |   |   | 59  |  
|Total interest expense              |  | $                                        | 3,942 |      | $ | 1,886  |   | $   | 1,255 |   | $ | 801 |  
|                                    |  |                                          |       |      |   |        |   |     |       |   |   |     |  
|Net interest
 income                |  | $                                        | 3,771 |      | $ | 857    |   | $   | 2,969 |   | $ | (55 | )
|                                    |  |                                          |       |      |   |        |   |     |       |   |   |     |  

| |    |                                                                                                                         
| | -- | ------------------------------------------------------------------------------------------------------------------------
| | 1. | The volume change in net
 interest income represents the change in average balance divided by the
 previous years rate.
|
| | 2. | The rate change in net
 interest income represents the change in rate divided by the previous years
 average balance.  
|
| | 3. | The mix change in net
 interest income represents the change in average balance multiplied by the
 change in rate.      

43

---



NON-INTEREST INCOME

The Companys
non-interest income consists primarily of service charges on deposit accounts,
gain on sale of loans and ATM and other service fees. For the year ended
December 31, 2007, non-interest income represented 7.31% of the Companys
revenues versus 8.88% in 2006, and 11.67% in 2005.

Total
non-interest income decreased slightly to $2.47 million in 2007 from $2.58
million in 2006 which was a slight increased from $2.48 million in 2005.
Service charge income increased $25 thousand or 2.89% to $889 thousand in 2007.
Service charge income increased $106 thousand in 2006 or 13.98% to $864
thousand, up from $758 thousand for the comparable period in 2005. The increase
in service charge income is the result of the increase in deposit accounts as a
result of the growth of the Company. The increase in service charges in 2007
and 2006 was offset by a decrease in gain on sales of loans of $144 thousand or
49.98% between 2007 and 2006 and $515 thousand or 63.66% between 2006 and 2005.
The decrease in the gain on sale of loans in 2007 and 2006 are due to both the
timing of the sale of the loans and the changes in the number and dollar amount
of loans sold. Other income increased $1 thousand to $1.43 million in 2007 over
2006 and increased $511 thousand or 56.53% in 2006 from $914 thousand in 2005.
Sources of other incomes remained constant in 2007 compared to 2006. The
increase in 2006 over 2005 was primarily the result of an increase in fee
income derived from the referral of commercial mortgage loans to third parties.

The following
table sets forth a summary of non-interest income for the periods indicated.

|                             |  |                          |       |                |   |       |  |   |       | 
|---------------------------- |  | ------------------------ | ----- | -------------- | - | ----- |  | - | ----- | 
|Table 33: Noninterest Income |  | Years Ended December 31, |      
|                             |  |                          |      
|                             |  | 2007                     |       | 2006           |   | 2005  | 
|                             |  |                          |       |                |   |       | 
|                             |  |                          |       | (In thousands) |   |       | 
|Service
 charges             |  | $                        | 889   |                | $ | 864   |  | $ | 758   | 
|Gain on sale
 of loans       |  |                          | 150   |                |   | 294   |  |   | 809   | 
|Other income                 |  |                          | 1,426 |                |   | 1,425 |  |   | 914   | 
|                             |  |                          |       |                |   |       | 
|Total
 non-interest income   |  | $                        | 2,465 |                | $ | 2,583 |  | $ | 2,481 | 
|                             |  |                          |       |                |   |       | 

NON-INTEREST EXPENSE

Non-interest
expense consists of salaries and related employee benefits, occupancy and
equipment expenses, professional fees, appraisal fees, directors fees,
postage, stationery and supplies expenses, telephone expenses, data processing
expenses, advertising and promotion expense and other operating expenses.
Non-interest expense for 2007 was $11.0 million compared to $10.4 million for
2006 and $9.1 million in 2005, representing an increase of $0.6 million or
5.77% for 2007, and $1.3 million or 13.84% for 2006. The decrease in salary and
benefits in 2007 over 2006 of $143,000 was primarily the result of staff
turnover, efficiencies realized on upgraded systems and management focus on
controlling increases in salaries and benefits. Increases in salaries and
benefits in 2006 over 2005 are indicative of the continuing additions to staff
the expanded branch operations in line with their growth over the two years
ended December 31, 2006. In addition the Company began to recognize share based
compensation expenses in 2006 resulting in $309 thousand of expense in 2007 and
$229 thousand in 2006, as a result of adopting SFAS No. 123(R). For additional
information related to the adoption of SFAS 123(R), please see notes 2 and 11
of the consolidated financial statements. The increase in occupancy and
equipment expense of $236 thousand in 2007 over 2006 is attributable to the
addition of the new branches in Lodi and Hayward in 2006. Data Processing
expense increased by $205 thousand in 2007 over 2006 levels; the increase is
primarily attributable to the costs associated with implementing electronic
clearing of paper check items. Advertising expense increased in 2007 and 2006
due to a focus on increasing market share and increased costs associated with
retaining customers. Other expense increased in 2007 over 2006 primarily due to
correspondent bank charges and other costs associated with the growth of the
Company. Other expenses decreased slightly in 2006 over 2005 as a result of
decreased miscellaneous operating losses offset by slightly higher
correspondent banking charges associated with volume of items processed.

44

---



The following
table sets forth a summary of non-interest expense for the periods indicated.

Table 34: Noninterest Expense

|                                   |  |                         |        |      |   |        |  |   |       | 
|---------------------------------- |  | ----------------------- | ------ | ---- | - | ------ |  | - | ----- | 
|                                   |  | Year Ended December 31, |       
|                                   |  |                         |       
|                                   |  | (In thousands)          |       
|                                   |  | 2007                    |        | 2006 |   | 2005   | 
|                                   |  |                         |        |      |   |        | 
|Salaries
  & benefits              |  | $                       | 5,336  |      | $ | 5,479  |  | $ | 4,742 | 
|Occupancy
  & equipment            |  |                         | 1,888  |      |   | 1,652  |  |   | 1,446 | 
|Professional
  fees                |  |                         | 294    |      |   | 349    |  |   | 397   | 
|Appraisal
  fees                   |  |                         | 266    |      |   | 337    |  |   | 255   | 
|Directors
  fees                   |  |                         | 290    |      |   | 274    |  |   | 259   | 
|Postage,
  stationery and supplies |  |                         | 212    |      |   | 184    |  |   | 196   | 
|Telephone                          |  |                         | 251    |      |   | 210    |  |   | 190   | 
|Data
  processing                  |  |                         | 491    |      |   | 286    |  |   | 243   | 
|Advertising
  and promotion        |  |                         | 545    |      |   | 365    |  |   | 127   | 
|Other
  operating expenses         |  |                         | 1,424  |      |   | 1,224  |  |   | 1,245 | 
|                                   |  |                         |        |      |   |        |  |   |       | 
|Total
  noninterest expense        |  | $                       | 10,997 |      | $ | 10,360 |  | $ | 9,100 | 
|                                   |  |                         |        |      |   |        |  |   |       | 

PROVISION FOR INCOME TAXES

The Companys provision for income taxes includes both federal income
and state franchise taxes and reflects the application of federal and state
statutory rates to the Companys net income before taxes. The principal
difference between statutory tax rates and the Companys effective tax rate is
the benefit derived from investing in tax-exempt securities and Company owned
life insurance. Increases and decreases in the provision for taxes primarily
reflect changes in the Companys net income before tax. The following table
reflects the Companys tax provision and the related effective tax rate for the
periods indicated.

The following
table reflects the Companys tax provision and the related effective tax rate
for the periods indicated.

Table 35: Tax Provision

|                       |  |                          |       |      |   |       |   |   |       |  
|---------------------- |  | ------------------------ | ----- | ---- | - | ----- | - | - | ----- | -
|                       |  | Years Ended December 31, |      
|                       |  |                          |      
|(Dollars in
thousands) |  | 2007                     |       | 2006 |   | 2005  |  
|                       |  |                          |       |      |   |       |  
|                      
|Tax
  Provision        |  | $                        | 2,894 |      | $ | 3,627 |   | $ | 2,596 |  
|Effective
  Tax Rate   |  |                          | 38.88 | %    |   | 39.56 | % |   | 37.72 | %

FINANCIAL CONDITION

Investment Securities

The Company
classifies its investment securities as held-to-maturity
or available-for-sale at the
time of investment purchase. Generally, all securities are purchased with the
intent and ability to hold them for long-term investment, and the Company has
both the ability and intent to hold held-to-maturity investments to maturity.
The Company does not engage in trading activities.

Investment
securities held-to-maturity are
carried at cost adjusted for the accretion of discounts and amortization of
premiums. Securities available-for-sale
may be sold to implement the Companys
asset/liability management strategies and in response to changes in
interest rates, prepayment rates and similar factors. Securities
available-for-sale are recorded at fair value and unrealized gains or losses,
net of income taxes, are reported as accumulated other comprehensive income or
loss, in a separate component of shareholders equity. Gain or loss on sale of
investment securities is based on the specific identification method.

Investment
securities held-to-maturity at
December 31, 2007, consisted of mortgage-backed securities totaling $58
thousand with a remaining contractual maturity of 7 to 14 years and a
weighted-average yield to maturity of 7.11%.

45

---



The following
table summarizes the contractual maturities of the Companys investment
securities at their carrying value and their weighted-average yields at
December 31, 2007. The yield on tax-exempt securities has not been adjusted to
a tax-equivalent yield basis.

Table 36: Investment Yields

|                                      |  |                 |        |                     |  |                     |   |                |       |        |  |       |   |        |    |       |  |        |   |       |        |  |  |      |   |   |        |  |  |      |  
|------------------------------------- |  | --------------- | ------ | ------------------- |  | ------------------- | - | -------------- | ----- | ------ |  | ----- | - | ------ | -- | ----- |  | ------ | - | ----- | ------ |  |  | ---- | - | - | ------ |  |  | ---- | -
|(Dollars in thousands)                |  | Within One Year |        | One to Five 
 Years |  | Five to Ten 
 Years |   | Over Ten Years |       | Total  | 
|                                      |  |                 |        |                     |  |                     |   |                |       |        | 
|                                      |  | Amount          |        | Yield               |  | Amount              |   | Yield          |       | Amount |  | Yield |   | Amount |    | Yield |  | Amount |   | Yield |       
|Available-for-sale                    |  |                 |        |                     |  |                     |   |                |       |        |  |       |   |        |    |       |  |        |   |       |        |  |  |      |   |   |        |  |  |      |  
|securities:                           |  |                 |        |                     |  |                     |   |                |       |        |  |       |   |        |    |       |  |        |   |       |        |  |  |      |   |   |        |  |  |      |  
|US Government Agencies and Treasuries |  | $               | 17,924 |                     |  | 4.41                | % | $              | 996   |        |  | 5.00  | % | $      |   |       |  |       | % | $     | 1,450  |  |  | 6.22 | % | $ | 20,370 |  |  | 4.57 | %
|                                      |  |                 |        |                     |  |                     |   |                |       |        |  |       |   |        |    |       |  |        |   |       |        |  |  |      |   |   |        |  |  |      |  
|Municipal Obligations                 |  |                 | 135    |                     |  | 3.75                | % |                | 205   |        |  | 3.50  | % |        |   |       |  |       | % |       | 2,719  |  |  | 4.75 | % |   | 3,059  |  |  | 4.62 | %
|                                      |  |                 |        |                     |  |                     |   |                |       |        |  |       |   |        |    |       |  |        |   |       |        |  |  |      |   |   |        |  |  |      |  
|Corporate and Other Bonds             |  |                 |       |                     |  |                    | % |                |      |        |  |      | % |        |   |       |  |       | % |       | 9,755  |  |  | 6.24 | % |   | 9,755  |  |  | 6.24 | %
|Mortgage- backed securities           |  |                 |       |                     |  |                    | % |                | 514   |        |  | 3.46  | % |        |   |       |  |       | % |       | 8,240  |  |  | 6.43 | % |   | 8,754  |  |  | 6.26 | %
|                                      |  |                 |        |                     |  |                     |   |                |       |        |  |       |   |        |    |       |  |        |   |       |        |  |  |      |   |   |        |  |  |      |  
|                                      |  |                 |        |                     |  |                     |   |                |       |        |  |       |   |        |    |       |  |        |   |       |        |  |  |      |   |   |        |  |  |      |  
|Total available-for-sale securities   |  |                 | 18,059 |                     |  | 4.41                | % |                | 1,715 |        |  | 4.36  | % |        |   |       |  |       | % |       | 22,164 |  |  | 6.13 | % |   | 41,938 |  |  | 5.31 | %
|                                      |  |                 |        |                     |  |                     |   |                |       |        |  |       |   |        |    |       |  |        |   |       |        |  |  |      |   |   |        |  |  |      |  
|                                      |  |                 |        |                     |  |                     |   |                |       |        |  |       |   |        |    |       |  |        |   |       |        |  |  |      |   |   |        |  |  |      |  
|Held-to-maturity                      |  |                 |        |                     |  |                     |   |                |       |        |  |       |   |        |    |       |  |        |   |       |        |  |  |      |   |   |        |  |  |      |  
|Securities                            |  |                 |        |                     |  |                     |   |                |       |        |  |       |   |        |    |       |  |        |   |       |        |  |  |      |   |   |        |  |  |      |  
|Mortgage-backed securities            |  | $               |       |                     |  |                    | % | $              |      |        |  |      | % | $      | 39 |       |  | 7.28   | % | $     | 19     |  |  | 6.74 | % | $ | 58     |  |  | 7.11 | %
|                                      |  |                 |        |                     |  |                     |   |                |       |        |  |       |   |        |    |       |  |        |   |       |        |  |  |      |   |   |        |  |  |      |  

The following
table summarizes the carrying value of the Companys investment securities held
on the dates indicated.

Table 37: Investment Balances

|                                                 |  |                    |        |      |   |        |  |   |        | 
|------------------------------------------------ |  | ------------------ | ------ | ---- | - | ------ |  | - | ------ | 
|                                                 |  | As of December 31, |       
|(Dollars in
thousands)                           |  | 2007               |        | 2006 |   | 2005   | 
|                                                 |  |                    |        |      |   |        | 
|Available-for-sale Securities  at fair value:   |  |                    |        |      |   |        |  |   |        | 
|U.S.
 Government & Agencies                      |  | $                  | 20,417 |      | $ | 13,733 |  | $ | 14,852 | 
|Municipal
 Obligations                           |  |                    | 3,161  |      |   | 2,760  |  |   | 2,865  | 
|Corporate
 and Other Bonds                       |  |                    | 9,592  |      |   | 2,506  |  |   | 3,325  | 
|Mortgage-
 backed securities                     |  |                    | 8,124  |      |   | 4,035  |  |   | 7,374  | 
|                                                 |  |                    |        |      |   |        |  |   |        | 
|Total
 available-for-sale                        |  | $                  | 41,294 |      | $ | 23,034 |  | $ | 28,416 | 
|                                                 |  |                    |        |      |   |        |  |   |        | 
|                                                 |  |                    |        |      |   |        |  |   |        | 
|Held-to-maturity Securities  at amortized cost: |  |                    |        |      |   |        |  |   |        | 
|Mortgage-backed
 Securities                      |  | $                  | 58     |      | $ | 73     |  | $ | 123    | 
|                                                 |  |                    |        |      |   |        |  |   |        | 

As of December
31, 2007, the aggregate book value of the Companys investment in securities of
a single issuer did not exceed 10% of the companys shareholders equity.

LOANS AND ASSET QUALITY

The Company
concentrates its lending activities primarily within Alameda, Calaveras, San
Joaquin, Stanislaus and Tuolumne Counties.

The
Company manages its credit risk through diversification of its loan portfolio
and the application of underwriting policies and procedures and credit
monitoring practices. Although the Company has a diversified loan portfolio, a
significant portion of its borrowers ability to repay the loans is dependent
upon the professional services and residential real estate development industry
sectors. Generally, the loans are secured by real estate or other assets and
are expected to be repaid from cash flows of the borrower or proceeds from the
sale of collateral.

46

---



The following
table sets forth the amounts of loans outstanding by category as of the dates
indicated:

Table 38: Loan Categories

|                                 |  |                    |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|-------------------------------- |  | ------------------ | ------- | ---- | - | ------- | - | ---- | ------- | ---- | - | ------- | - | - | ------- | -
|(Dollars in thousands)           |  | As of December 31, |        
|                                 |  |                    |        
|                                 |  | 2007               |         | 2006 |   | 2005    |   | 2004 |         | 2003 |  
|                                 |  |                    |         |      |   |         |   |      |         |      |  
|Commercial and Agricultural      |  | $                  | 95,658  |      | $ | 89,045  |   | $    | 60,645  |      | $ | 55,569  |   | $ | 57,638  |  
|                                 |  |                    |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Real estate-construction         |  |                    | 80,168  |      |   | 75,654  |   |      | 43,352  |      |   | 22,965  |   |   | 28,219  |  
|                                 |  |                    |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Real estate-commercial
 mortgage |  |                    | 121,157 |      |   | 112,532 |   |      | 126,166 |      |   | 109,895 |   |   | 60,174  |  
|                                 |  |                    |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Installment                      |  |                    | 15,215  |      |   | 12,526  |   |      | 13,536  |      |   | 13,121  |   |   | 10,823  |  
|                                 |  |                    |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Deferred Loan Fees and
 Costs    |  |                    | 208     |      |   | 40      |   |      | 213     |      |   | 199     |   |   | 284     |  
|                                 |  |                    |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Allowance for Loan Losses        |  |                    | (3,948  | )    |   | (2,478  | ) |      | (2,356  | )    |   | (2,214  | ) |   | (1,653  | )
|                                 |  |                    |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|                                 |  |                    |         |      |   |         |   |      |         |      |   |         |   |   |         |  
|Total Net Loans                  |  | $                  | 308,458 |      | $ | 287,318 |   | $    | 241,556 |      | $ | 199,535 |   | $ | 155,485 |  
|                                 |  |                    |         |      |   |         |   |      |         |      |   |         |   |   |         |  

Net loans have
increased $21.1 million or 7.36%, to $308.5 million at December 31, 2007 from
$287.3 million at December 31, 2006. The Companys loan portfolio has grown in
the commercial and agricultural categories by $6.6 million or 7.43% in 2007.
Real estate construction loans have increased $4.5 million or 5.97%, real
estate commercial mortgage loans increased $8.6 million or 7.66% and
installment loans have increased $2.7 million or 21.47% in 2007. The portfolio
mix has changed in 2007 as compared with the mix of the previous year with
commercial and agricultural loans increasing to 31.0% compared to 26.0% in
2006, of total net loans, real estate construction loans decreased to 26.0% compared to
26.3% in 2006, real estate - commercial mortgage loans decreased to 39.3%,
compared to 44.4% and Installment loans increased to 4.9% compared to 4.1% in
2006. The shift in the mix reflects the changes in lending needs within the
Companys service area. The overall change in the mix of the loan portfolio did
not significantly impact the overall risk profile in the loan portfolio.

The
following table sets forth the maturity distribution of the Companys
commercial and agricultural loans and construction loans outstanding as of
December 31, 2007, which, based on remaining scheduled repayments of principal,
were due within the periods indicated.

Table 39: Commercial, Agriculture and
Construction Loan Maturities

|                                   |  |                 |         |  |                              |        |  |   |        |  |   |         | 
|---------------------------------- |  | --------------- | ------- |  | ---------------------------- | ------ |  | - | ------ |  | - | ------- | 
|                                   |  |                 |         |  | After One
through Five
Years |        |  |   |        |  |   |        
|                                   |  | Within One
Year |         |  | After Five
Years             |        |  |   |       
|(Dollars in
thousands)             |  |                 |         |  | Total                        |       
|                                   |  |                 |         |  |                              |        |  |   |       
|Commercial
 and agricultural loans |  | $               | 47,099  |  | $                            | 25,447 |  | $ | 23,112 |  | $ | 95,658  | 
|                                  
|Construction
 Loans                |  |                 | 71,514  |  |                              | 6,848  |  |   | 1,806  |  |   | 80,168  | 
|                                   |  |                 |         |  |                              |        |  |   |        |  |   |         | 
|Total                              |  | $               | 118,613 |  | $                            | 32,295 |  | $ | 24,918 |  | $ | 176,239 | 
|                                   |  |                 |         |  |                              |        |  |   |        |  |   |         | 
|Loans due
 after one year with:    |  |                 |         |  |                              |        |  |   |        |  |   |         | 
|Fixed Rates                        |  |                 |         |  | $                            | 21,793 |  | $ | 2,930  |  | $ | 24,723  | 
|Variable
 Rates                    |  |                 |         |  | $                            | 10,502 |  | $ | 21,988 |  | $ | 32,490  | 
|                                   |  |                 |         |  |                              |        |  |   |        |  |   |         | 

The Companys
practice is to place a loan on nonaccrual status when one of the following
events occurs:(i) Any installment of principal or interest is 90 days or more past
due (unless in managements opinion the loan is well-secured and in the process
of collection), (ii) management determines the ultimate collection of principal or
interest to be unlikely or (iii) the terms of the loan have been renegotiated
due to a serious weakening of the borrowers financial condition. Nonperforming
loans are loans that are on nonaccrual, are 90 days past due and still accruing
or have been restructured.

47

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The following
table sets forth a summary of the Companys nonperforming loans and other
assets as of the dates indicated:

Table 40: Nonperforming Assets

|                                               |  |                    |     |      |   |      |  |      |   |      |   |   |  |   |   | 
|---------------------------------------------- |  | ------------------ | --- | ---- | - | ---- |  | ---- | - | ---- | - | - |  | - | - | 
|                                               |  | As of December 31, |    
|                                               |  |                    |    
|(Dollars in
Thousands)                         |  | 2007               |     | 2006 |   | 2005 |  | 2004 |   | 2003 |  
|                                               |  |                    |     |      |   |      |  |      |   |      |  
|Nonaccrual loans                               |  | $                  | 432 |      | $ |     |  | $    |  |      | $ |  |  | $ |  | 
|90 days past due and still accruing
  interest |  |                    |    |      |   |     |  |      |  |      |   |  |  |   |  | 
|Other Real Estate Owned                        |  |                    |    |      |   |     |  |      |  |      |   |  |  |   |  | 

The Company
had one nonaccrual loan as of December 31, 2007 and did not have any nonaccrual
loans at December 31, 2006 or 2005.

ALLOWANCE FOR LOAN LOSSES (ALL)
In determining the amount of the Companys Allowance for Loan Losses (ALL),
management assesses probable loss characteristics of the loan portfolio
including the concentrations, nature and diversification of the portfolio. Each
credit is assigned a credit risk rating factor, and this factor, multiplied by
the dollars associated with the credit risk rating, is used to calculate one
component of the ALL. In addition, management estimates the probable loss on
individual credits that are receiving increased management attention due to
identified increases in credit risk. Management reviews the credit risk report
with the Director Loan Committee on a weekly basis as well as with the full
Board monthly.

The
adequacy of the ALL is calculated upon three components. First is the credit
risk rating of the loan portfolio, including all outstanding loans. Every
extension of credit has been assigned a risk rating based upon a comprehensive
definition intended to measure the inherent risk of lending money. Each rating
has an assigned risk factor expressed as a reserve percentage. Central to this
assigned risk factor is the historical loss record of the Company. Secondly,
established specific reserves are available for individual loans currently on
managements watch and classified loan lists. These are the estimated potential
losses associated with specific borrowers based upon the collateral and
event(s) causing the risk ratings. The third component is unallocated. This
reserve is for qualitative factors that may affect the portfolio as a whole,
such as those factors described below. Management believes the assigned risk
grades and our methods for managing risk are satisfactory.

The
Company makes provisions to the ALL on a regular basis through charges to
operations that are reflected in the Companys statements of income as a
provision for loan losses. When a loan is deemed uncollectible, it is charged
against the allowance. Any recoveries of previously charged-off loans are
credited back to the allowance. There is no precise method of predicting
specific losses or amounts that ultimately may be charged-off on particular
categories of the loan portfolio. Similarly, the adequacy of the ALL and the
level of the related provision for probable loan losses is determined on a
judgment basis by management based on consideration of a number of factors
including (i) economic conditions, (ii) borrowers financial condition, (iii) loan
impairment, (iv) evaluation of industry trends, (v) industry and other
concentrations, (vi) loans which are contractually current as to payment terms
but demonstrate a higher degree of risk as identified by management, (vii)
continuing evaluation of the performing loan portfolio, (viii) monthly review
and evaluation of problem loans identified as having a loss potential, (ix)
monthly review by the Board of Directors, and (x) assessments by regulators and
other third parties. Certain members of Management and the Board of Directors
evaluate the allowance and determine its desired level considering objective
and subjective measures, such as knowledge of the borrowers businesses,
valuation of collateral, the determination of impaired loans and exposure to potential
losses.

While
management uses available information to recognize losses on loans, future
additions to the allowance may be necessary based on changes in economic
conditions and other qualitative factors. In addition, various regulatory agencies,
as an integral part of their examination process, periodically review the
Companys ALL. Such agencies may require the Company to provide additions to
the allowance based on their judgment of information available to them at the
time of their examination. There is uncertainty concerning future economic
trends. Accordingly it is not possible to predict the effect future economic
trends may have on the level of the provision for possible loan losses in
future periods.

48

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The
Companys principal lines of lending are (i) commercial and agricultural, (ii)
real estate construction and (iii) commercial and residential real estate. The
primary sources of repayment of the Companys commercial loans are the
borrowers conversion of short-term assets to cash and operating cash flow. The
net assets of the borrower or guarantor are usually identified as a secondary
source of repayment. The principal factors affecting the Companys risk of loss
from commercial lending include each borrowers ability to manage its business
affairs and cash flows, local and general economic conditions and real estate
values in the Companys service area. The Company manages its commercial loan
portfolio by monitoring its borrowers payment performance and their respective
financial condition and makes periodic adjustments, if necessary, to the risk
grade assigned to each loan in the portfolio. The Companys evaluations of its
borrowers are facilitated by managements knowledge of local market conditions
and periodic reviews by a consultant of the Companys credit administration
policies.

The
principal source of repayment of the Companys real estate construction loans
is the sale of the underlying collateral or the availability of permanent
financing from the Company or other lending source. The principal risks
associated with real estate construction lending include project cost overruns
and deterioration of real estate values as a result of various factors,
including competitive pressures and economic downturns. The Company manages its
credit risk associated with real estate construction lending by establishing
loan-to-value ratios and loan-to-cost ratios on projects on an as-completed
basis, inspecting project status in advance of controlled disbursements and matching
maturities with expected completion dates. Generally, the Company requires a
loan-to-value ratio of not more than 80% on single family residential
construction loans.

The
principal source of repayment of the Companys real estate mortgage loans is
the borrowers operating cash flow. Similar to commercial loans, the principal
factors affecting the Companys risk of loss in real estate mortgage lending
include each borrowers ability to manage its business affairs and cash flows,
local and general economic conditions and real estate values in the Companys
service area. The Company manages its credit risk associated with real estate
mortgage lending primarily by establishing maximum loan-to-value ratios and
using strategies to match the borrowers cash flow to loan repayment terms.

The
Companys specific underwriting standards and methods for each of its principal
lines of lending include industry-accepted analysis and modeling and certain
proprietary techniques. The Companys underwriting criteria are designed to
comply with applicable regulatory guidelines, including required loan-to-value
ratios. The Companys credit administration policies contain mandatory lien
position and debt service coverage requirements, and the Company generally
requires a guarantee from 20% or more owners of its corporate borrowers.

The
ALL should not be interpreted as an indication that charge-offs in future
periods will occur in the stated amounts or proportions.

The following
table summarizes the Companys loan loss experience as well as provisions and
charges to the allowance for loan losses and certain ratios for the periods
indicated.

Table 41: Allowance for Loan Loss Activity

|                                                         |  |                          |       |      |   |       |   |      |       |      |   |       |    |   |       |  
|-------------------------------------------------------- |  | ------------------------ | ----- | ---- | - | ----- | - | ---- | ----- | ---- | - | ----- | -- | - | ----- | -
|                                                         |  | Years Ended December 31, |      
|                                                         |  |                          |      
|(Dollars in
thousands)                                   |  | 2007                     |       | 2006 |   | 2005  |   | 2004 |       | 2003 |  
|                                                         |  |                          |       |      |   |       |   |      |       |      |  
|                                                         |  |                          |       |      |   |       |   |      |       |      |   |       |    |   |       |  
|Beginning Balance:                                       |  | $                        | 2,478 |      | $ | 2,356 |   | $    | 2,214 |      | $ | 1,653 |    | $ | 1,307 |  
|                                                         |  |                          |       |      |   |       |   |      |       |      |   |       |    |   |       |  
|Provision for loan losses                                |  |                          | 1,425 |      |   | 360   |   |      | 35    |      |   | 504   |    |   | 536   |  
|Charge-offs:                                             |  |                          |       |      |   |       |   |      |       |      |   |       |    |   |       |  
|Commercial                                               |  |                          | (143  | )    |   | (10   | ) |      |      |      |   | (9    | )  |   | (90   | )
|Real Estate                                              |  |                          |      |      |   |      |   |      |      |      |   |      |    |   |      |  
|Other                                                    |  |                          | (18   | )    |   | (14   | ) |      | (17   | )    |   |      |    |   | (105  | )
|                                                         |  |                          |       |      |   |       |   |      |       |      |   |       |    |   |       |  
|Total Charge-offs                                        |  |                          | (161  | )    |   | (24   | ) |      | (17   | )    |   | (9    | )  |   | (195  | )
|                                                         |  |                          |       |      |   |       |   |      |       |      |   |       |    |   |       |  
|Recoveries:                                              |  |                          |       |      |   |       |   |      |       |      |   |       |    |   |       |  
|Commercial                                               |  |                          | 203   |      |   |      |   |      | 124   |      |   | 66    |    |   | 1     |  
|Other                                                    |  |                          | 3     |      |   | 1     |   |      |      |      |   |      |    |   | 4     |  
|Total Recoveries                                         |  |                          | 206   |      |   | 1     |   |      | 124   |      |   | 66    |    |   | 5     |  
|                                                         |  |                          |       |      |   |       |   |      |       |      |   |       |    |   |       |  
|                                                         |  |                          |       |      |   |       |   |      |       |      |   |       |    |   |       |  
|Reclassification of the reserve for unfunded commitments |  |                          |      |      |   | (215  | ) |      |      |      |   |      |    |   |      |  
|                                                         |  |                          |       |      |   |       |   |      |       |      |   |       |    |   |       |  
|Ending Balance                                           |  | $                        | 3,948 |      | $ | 2,478 |   | $    | 2,356 |      | $ | 2,214 |    | $ | 1,653 |  
|                                                         |  |                          |       |      |   |       |   |      |       |      |   |       |    |   |       |  
|                                                         |  |                          |       |      |   |       |   |      |       |      |   |       |    |   |       |  
|ALL to total loans                                       |  |                          | 1.26  | %    |   | 0.86  | % |      | 0.98  | %    |   | 1.10  | %  |   | 1.05  | %
|Net (recoveries) charge-offs to average loans            |  |                          | (0.02 | )%   |   | 0.01  | % |      | (.01  | )%   |   | (.03  | )% |   | .12   | %
|                                                         |  |                          |       |      |   |       |   |      |       |      |   |       |    |   |       |  

49

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The provision
for loan losses was $1,425,000 for 2007 compared to $360,000 for 2006 and
$35,000 for 2005. The increase of $1,065,000 in the provision for loan losses,
in 2007 over 2006, represented potential losses from specific customers and not
degradation of overall credit quality in the loan portfolio. The increase in the amount of the
provision in 2006 compared to 2005 is a direct result of growth in the
portfolio in addition to the analysis of the loan portfolio and the loan loss
history of the Company. Net (recoveries) charge-offs were $(45,000) or .02% of
average loans for 2007 compared to $23,000 or .01% of average loans for 2006
and $(107,000) or .05% of average loans for 2005. Management does not believe
that there were any trends indicated by the detail of the aggregate charge-offs
for any of the periods discussed.

The following
table summarizes the allocation of the allowance for loan losses (ALL) by loan
type and the loans as a percent of loans outstanding in each loan category at
the dates indicated

|                                                |  |      |       |  |  |        |      |   |       |  |  |        |   |   |       |  |      |        |   |   |       |      |  |        |   |   |       |  |  |        |  
|----------------------------------------------- |  | ---- | ----- |  |  | ------ | ---- | - | ----- |  |  | ------ | - | - | ----- |  | ---- | ------ | - | - | ----- | ---- |  | ------ | - | - | ----- |  |  | ------ | -
|Table 42: Allocation of Allowance for Loan Loss |  |      |       |  |  |        |      |   |       |  |  |        |   |  
|                                               
|(Dollars in thousands)                          |  |      |       |  |  |        |      |   |       |  |  |        |   |  
|                                               
|                                                |  |      |       |  |  |        |      |   |       |  |  |        |   |   |       |  |      |        |   |   |       |      |  |        |   |  
|                                                |  | 2007 |       |  |  |        | 2006 |   |       |  |  | 2005   |   |   |       |  | 2004 |        |   |   |       | 2003 |  |        |   |  
|                                                |  |      |       |  |  |        |      |   |       |  |  |        |   |   |       |  |      |        |   |   |       |      |  |        |   |  
|Commercial and
 Agricultural                    |  | $    | 1,584 |  |  | 30.77  | %    | $ | 1,086 |  |  | 25.82  | % | $ | 994   |  |      | 24.89  | % | $ | 880   |      |  | 27.57  | % | $ | 736   |  |  | 36.75  | %
|Real estate
  construction                     |  |      | 757   |  |  | 25.68  | %    |   | 269   |  |  | 26.11  | % |   | 196   |  |      | 17.79  | % |   | 115   |      |  | 11.39  | % |   | 141   |  |  | 17.94  | %
|Real estate
  commercial                       |  |      | 563   |  |  | 39.58  | %    |   | 642   |  |  | 44.01  | % |   | 501   |  |      | 51.77  | % |   | 422   |      |  | 54.52  | % |   | 229   |  |  | 38.36  | %
|Installment                                     |  |      | 293   |  |  | 3.97   | %    |   | 279   |  |  | 4.06   | % |   | 300   |  |      | 5.55   | % |   | 308   |      |  | 6.52   | % |   | 248   |  |  | 6.95   | %
|Unallocated                                     |  |      | 751   |  |  |       |      |   | 202   |  |  |       |   |   | 365   |  |      |       |   |   | 489   |      |  |       |   |   | 305   |  |  |       |  
|                                                |  |      |       |  |  |        |      |   |       |  |  |        |   |   |       |  |      |        |   |   |       |      |  |        |   |   |       |  |  |        |  
|Total                                           |  | $    | 3,948 |  |  | 100.00 | %    | $ | 2,478 |  |  | 100.00 | % | $ | 2,356 |  |      | 100.00 | % | $ | 2,214 |      |  | 100.00 | % | $ | 1,653 |  |  | 100.00 | %
|                                                |  |      |       |  |  |        |      |   |       |  |  |        |   |   |       |  |      |        |   |   |       |      |  |        |   |   |       |  |  |        |  
|                                                |  |      |       |  |  |        |      |   |       |  |  |        |   |   |       |  |      |        |   |   |       |      |  |        |   |   |       |  |  |        |  

DEPOSITS

The Company
primarily obtains deposits from local businesses and professionals as well as
through certificates of deposit, savings and checking accounts.

The following
table sets forth the remaining maturities of certificates of deposit at
December 31, 2007

|                                    |  |                |        |               |   |         | 
|----------------------------------- |  | -------------- | ------ | ------------- | - | ------- | 
|Table 43: Deposit Maturity Schedule |  |                |        |               |   |         | 
|                                   
|(Dollars in
thousands)              |  | Under
$100,000 |        | Over
$100,000 |  
|                                    |  |                |        |               |  
|Three Months or less                |  | $              | 26,400 |               | $ | 37,335  | 
|Over three through six months       |  |                | 19,422 |               |   | 34,123  | 
|Over six through twelve months      |  |                | 14,713 |               |   | 42,423  | 
|Over twelve months                  |  |                | 8,823  |               |   | 13,850  | 
|                                    |  |                |        |               |   |         | 
|Total                               |  | $              | 69,358 |               | $ | 127,731 | 
|                                    |  |                |        |               |   |         | 

LIQUIDITY AND MARKET RISK

The purpose of
liquidity management is to ensure efficient and economical funding of the
Companys assets consistent with the needs of the Companys depositors and, to
a lesser extent, shareholders. This process is managed not by formally
monitoring the cash flows from operations, investing and financing activities
as described in the Companys statement of cash flows, but through an
understanding principally of depositor and borrower needs. As loan demand
increases, the Company can use asset liquidity from maturing investments along
with deposit growth to fund the new loans.

With
respect to assets, liquidity is provided by receipts from cash and money market
investments such as interest-bearing time deposits, federal-funds sold,
available-for-sale investment securities, and by principal and interest
payments on loans. With respect to liabilities, liquidity is provided by core
deposits, shareholders equity and the ability of the Company to borrow funds
and to generate deposits.

Because
estimates of the liquidity needs of the Company may vary from actual needs, the
Company maintains a substantial amount of liquid assets to absorb short-term
increases in loans or reductions in deposits. As loan demand decreases or loans
are paid off, investment assets can absorb these excess funds or deposit rates
can be decreased to run off excess liquidity. Therefore, there is some
correlation between financing activities associated with deposits and investing
activities associated with lending. The Companys liquid assets (cash and due
from banks, federal funds sold, interest bearing deposits in banks and
available-for-sale investment securities) totaled $89.9 million or 20.8% of
total assets at December 31, 2007, $73.7 million or 19.0% of total assets at
December 31, 2006 and $47.5 million or 15.4% of total assets at December 31,
2005. The Company expects that its primary source of liquidity will be earnings
of the Company, acquisition of core deposits, and wholesale borrowing
arrangements.

50

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MARKET RISK

Market risk is
the risk of loss in a financial instrument arising from adverse changes in
market rates and processes such as interest rates, commodity prices and equity
prices. As typical for a financial institution, the Companys market risk
arises primarily from interest rate risk exposure. Fluctuation in interest
rates will ultimately impact both the level of income and expense recorded on a
large portion of the Companys assets and liabilities, and the market value of
all interest earning assets and interest bearing liabilities, other than those
that possess a short term to maturity. Based upon the nature of its operations,
the Company is not subject to foreign currency exchange or commodity pricing.
However, the Companys commercial real estate loan portfolio, concentrated
primarily in Northern California, is subject to risks associated with the local
economies.

The
fundamental objective of the Companys management of its assets and liabilities
is to maximize the economic value of the Company while maintaining adequate
liquidity and managing exposure to interest rate risk deemed by management to
be acceptable. Management believes an acceptable degree of exposure to interest
rate risk results from management of assets and liabilities through using
floating rate loans and deposits, maturities, pricing and mix to attempt to
neutralize the potential impact of changes in market interest rates. The
Companys profitability is dependent to a large extent upon its net interest
income, which is the difference between its interest income on interest earning
assets, such as loans and securities, and interest expense on interest bearing
liabilities, such as deposits, trust preferred securities and other borrowings.
The Company, like other financial institutions, is subject to interest rate
risk to the degree that its interest earning assets reprice differently from
its interest bearing liabilities. The Company manages its mix of assets and
liabilities with the goal of limiting exposure to interest rate risk, ensuring
adequate liquidity, and coordinating its sources and uses of funds.

The
Company seeks to control its interest rate risk exposure in a manner that will
allow for adequate levels of earnings and capital over a range of possible
interest rate environments. The Company has adopted formal policies and
practices to monitor and manage interest rate exposure. As part of this effort,
the Company measures interest rate risk utilizing both an internal asset
liability measurement system as well as independent third party reviews to
confirm the reasonableness of the assumptions used to measure and report the
Companys interest rate risk, enabling management to make any adjustments
necessary.

Interest
rate risk is managed by the Companys Asset Liability Committee (ALCO), which
includes members of senior management and several members of the Board of
Directors. The ALCO monitors interest rate risk by analyzing the potential
impact on interest income from potential changes in interest rates and
considers the impact of alternative strategies or changes in balance sheet
structure. The ALCO manages the Companys balance sheet in part to maintain the
potential impact on net interest income within acceptable ranges despite
changes in interest rates. The Companys exposure to interest rate risk is
reviewed on at least a quarterly basis by the ALCO.

NET INTEREST INCOME SIMULATION

In order to
measure interest rate risk at December 31, 2007, the Company used a simulation
model to project changes in net interest income that result from forecasted
changes in interest rates. This analysis, which is performed quarterly by
management, calculates the difference between net interest income forecasted
using a rising and falling interest rate scenario and net interest income
forecasted using a base market derived from the current interest rates. The income
simulation model includes various assumptions regarding the re-pricing
relationships for each of the Companys products. Many of the Companys assets
are floating rate loans, which are assumed to reprice immediately and to the
same extent as the change in market rates according to their contracted index.
The Companys non-term deposit products reprice more slowly, usually changing
less than the change in market rates and at the discretion of the Company.

The
analysis indicates the impact of changes in net interest income for the given
set of rate changes and assumptions. It assumes that the balance sheet grows
modestly, but that its structure will remain similar to the structure at
year-end. It does not account for all factors that impact this analysis,
including the potential impact of loan prepayments, deposit drifts or other
balance sheet movements including changes by management to mitigate the impact
of interest rate changes or secondary impacts such as changes to the Companys
credit risk profile as interest rates change. Changes that vary significantly
from the assumptions may have significant effects on the Companys net interest
income.

51

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The following
table reflects the Companys projected net interest income sensitivity analysis
based on year-end data:

Table 44: Interest Income Sensitivity

|                        |  |                              |        |                          |  |       |   
|----------------------- |  | ---------------------------- | ------ | ------------------------ |  | ----- | --
|                        |  | December 31, 2007            |       
|                        |  |                              |       
|Change in
Rates         |  | Adjusted Net Interest
Income |        | Percent Change
From Base | 
|                        |  | (In thousands)               |       
|                        |  |                              |       
|Up 200 basis
  points   |  | $                            | 16,906 |                          |  | 3.99  | % 
|Up 150 basis
  points   |  | $                            | 16,753 |                          |  | 3.05  | % 
|Up 100 basis
  points   |  | $                            | 16,594 |                          |  | 2.07  | % 
|Base
  Scenario         |  | $                            | 16,257 |                          |  | 0.00  | % 
|Down 100
  basis points |  | $                            | 15,919 |                          |  | (2.08 | )%
|Down 150
  basis points |  | $                            | 15,743 |                          |  | (3.16 | )%
|Down 200
  basis points |  | $                            | 15,563 |                          |  | (4.27 | )%

CONTRACTUAL OBLIGATIONS

The following
table summarizes the contractual obligations of the Company as of December 31,
2007:

Table 45: Contractual Obligations

|                                                                               |  |       |        |                    |   |           |  |           |     |                   |   |     |  |   |        | 
|------------------------------------------------------------------------------ |  | ----- | ------ | ------------------ | - | --------- |  | --------- | --- | ----------------- | - | --- |  | - | ------ | 
|                                                                               |  | Total |        | Less than
one year |   | 1-3 years |  | 3-5 years |     | More than
5 years |  
|                                                                               |  |       |        |                    |   |           |  |           |     |                   |  
|Subordinated
  Debentures, floating rate 
  of 7.78% payable March 17, 2034    |  | $     | 3,609  |                    | $ |          |  | $         |    |                   | $ |    |  | $ | 3,609  | 
|Subordinated
  Debentures, floating rate
  of 6.44% payable September 16, 2037 |  |       | 5,155  |                    |   |          |  |           |    |                   |   |    |  |   | 5,155  | 
|FHLB Loans
  weighted average fixed rate of 3.87%                              |  |       | 40,000 |                    |   | 40,000    |  |           |    |                   |   |    |  |   |       | 
|Operating
  lease obligations                                                  |  |       | 2,127  |                    |   | 426       |  |           | 473 |                   |   | 417 |  |   | 811    | 
|Salary
  continuation plan (1)                                                 |  |       | 1,016  |                    |   |          |  |           |    |                   |   |    |  |   | 1,016  | 
|                                                                               |  |       |        |                    |   |           |  |           |     |                   |   |     |  |   |        | 
|Total                                                                          |  | $     | 51,907 |                    | $ | 40,426    |  | $         | 473 |                   | $ | 417 |  | $ | 10,591 | 
|                                                                               |  |       |        |                    |   |           |  |           |     |                   |   |     |  |   |        | 

|    |                                                                                                                        
|--- | -----------------------------------------------------------------------------------------------------------------------
|(1) | Salary
  continuation plan obligations represents amount accrued as of December 31,
  2007 under the terms of the plan.

In addition to
those obligations listed above, in the normal course of business, the Company
will make cash distributions for, among other items, the payment of interest on
interest bearing deposit accounts and debt obligations, payments for quarterly
tax estimates and contributions to certain employee benefit plans.

CAPITAL RESOURCES

Capital
adequacy is a measure of the amount of capital needed to sustain asset growth
and act as a cushion for losses. Capital protects depositors and the Federal
deposit insurance fund from potential losses and is a source of funds for the
investments the Company needs to remain competitive. Historically, capital has
been generated principally from the retention of earnings.

Overall
capital adequacy is monitored on a day-to-day basis by the Companys management
and reported to the Companys Board of Directors on a quarterly basis. The
Banks regulators measure capital adequacy by using a risk-based capital
framework and by monitoring compliance with minimum leverage ratio guidelines.
Under the risk-based capital standard, assets reported on the Companys balance
sheet and certain off-balance sheet items are assigned to risk categories, each
of which is assigned a risk weight.

This
standard characterizes an institutions capital as being Tier 1 capital
(defined as principally comprising shareholders equity and qualifying
subordinated debentures ) and Tier 2 capital (defined as principally
comprising the qualifying portion of subordinated debt and the qualifying
portion of the ALL), the total amount not to exceed 100% of Tier 1 capital.

The
minimum ratio of total risk-based capital to risk-adjusted assets, including
certain off-balance sheet items, is 8%.

At
December 31, 2007, 2006 and 2005 the Companys capital met all minimum
regulatory requirements.

As
of December 31, 2007, the most recent notification by the Federal Depository
Insurance Corporation (FDIC) categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized the Bank must meet the minimum ratios as set forth below. There are
no conditions or events since that notification that management believes have
changed the institutions category. For more information on the Companys and
the Banks risk-based capital ratios, see note 11 Shareholders Equity.

52

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IMPACT OF INFLATION

Inflation
affects the Companys financial position as well as its operating results. It
is managements opinion that the effects of inflation on the financial
statements have not been material.

QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

The following
table presents the summary unaudited results for the stated eight quarters:

Table 46: Quarterly Financial Results

|                                      |         |     |         |     |         |       |         |     |         |     |         |       |         |     |         |     |   |       |  |   |       |  |   |       | 
|------------------------------------- | ------- | --- | ------- | --- | ------- | ----- | ------- | --- | ------- | --- | ------- | ----- | ------- | --- | ------- | --- | - | ----- |  | - | ----- |  | - | ----- | 
|                                      |         |     |         |     | 2007    |       |         |     |         |     |         |       | 2006    |     |         |     |  
|                                      |         |     |         |     |         |       |         |     |         |     |         |       |         |     |         |     |  
|                                      |         |     |         |     |         |       |         |     |         |     |         |       |         |     |         |     |  
|(In
thousands, except per share data) |         | 4th |         | 3rd |         | 2nd   |         | 1st |         | 4th |         | 3rd   |         | 2nd |         | 1st |  
|                                      | Quarter |     | Quarter |     | Quarter |       | Quarter |     | Quarter |     | Quarter |       | Quarter |     | Quarter |    
|                                      |         |     |         |     |         |       |         |     |         |     |         |       |         |     |         |     |  
|Diluted
  earnings per share          |         | $   | 0.13    |     | $       | 0.33  |         | $   | 0.35    |     | $       | 0.33  |         | $   | 0.39    |     | $ | 0.39  |  | $ | 0.33  |  | $ | 0.31  | 
|Basic
  earnings per share            |         | $   | 0.14    |     | $       | 0.35  |         | $   | 0.38    |     | $       | 0.36  |         | $   | 0.43    |     | $ | 0.44  |  | $ | 0.37  |  | $ | 0.35  | 
|Interest
  income                     |         | $   | 7,667   |     | $       | 7,937 |         | $   | 8,132   |     | $       | 7,506 |         | $   | 7,440   |     | $ | 6,942 |  | $ | 6,321 |  | $ | 5,792 | 
|Net interest
  income                 |         | $   | 4,175   |     | $       | 4,241 |         | $   | 4,653   |     | $       | 4,331 |         | $   | 4,573   |     | $ | 4,463 |  | $ | 4,199 |  | $ | 4,072 | 
|Provision
  for loan losses           |         | $   | 1,165   |     | $       | 40    |         | $   | 55      |     | $       | 165   |         | $   | 90      |     | $ | 90    |  | $ | 90    |  | $ | 90    | 
|Total
  non-interest income           |         | $   | 484     |     | $       | 589   |         | $   | 706     |     | $       | 686   |         | $   | 766     |     | $ | 718   |  | $ | 500   |  | $ | 599   | 
|Total
  non-interest expense          |         | $   | 2,585   |     | $       | 2,711 |         | $   | 3,002   |     | $       | 2,699 |         | $   | 2,719   |     | $ | 2,602 |  | $ | 2,452 |  | $ | 2,587 | 
|Income
  before taxes                 |         | $   | 909     |     | $       | 2,079 |         | $   | 2,313   |     | $       | 2,142 |         | $   | 2,530   |     | $ | 2,489 |  | $ | 2,157 |  | $ | 1,994 | 
|Net Income                            |         | $   | 513     |     | $       | 1,301 |         | $   | 1,409   |     | $       | 1,326 |         | $   | 1,517   |     | $ | 1,512 |  | $ | 1,307 |  | $ | 1,207 | 
|                                      |         |     |         |     |         |       |         |     |         |     |         |       |         |     |         |     |   |       |  |   |       |  |   |       | 

53

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|                                                                                       
|---------------------------------------------------------------------------------------
|MARKET PRICE FOR REGISTRANTS COMMON EQUITY,
DIVIDENDS AND 
RELATED STOCKHOLDER MATTERS
|                                                                                       

The Companys common stock
is listed for trading on the NASDAQ Global Market under the symbol PSBC. Prior
to July 12, 2005, trading information regarding the common stock was available
via the OTC Bulletin Board. The following table, which summarizes trading
activity during the Companys last two fiscal years, is based on information
provided by Yahoo.com Historical Quotes. The quotations reflect the price that
would be received by the seller without retail mark-up, mark-down or
commissions and may not have represented actual transactions.

Table 47: Quarterly Sales Prices

|                   |  |              |       |     |   |        |  |  |         | 
|------------------ |  | ------------ | ----- | --- | - | ------ |  |  | ------- | 
|                   |  | Sales Prices |      
|                   |  |              |      
|Quarter
  Ended:   |  | High         |       | Low |   | Volume | 
|                   |  |              |       |     |   |        | 
|December 31, 2007  |  |              | 18.89 |     |   | 12.44  |  |  | 132,100 | 
|September 30, 2007 |  |              | 20.74 |     |   | 15.51  |  |  | 310,600 | 
|June 30, 2007      |  |              | 21.90 |     |   | 16.75  |  |  | 149,300 | 
|March 31, 2007     |  |              | 24.23 |     |   | 19.87  |  |  | 503,000 | 
|                   |  |              |       |     |   |        |  |  |         | 
|December 31, 2006  |  | $            | 23.90 |     | $ | 18.50  |  |  | 154,129 | 
|September 30, 2006 |  | $            | 19.25 |     | $ | 17.65  |  |  | 379,539 | 
|June 30, 2006      |  | $            | 18.99 |     | $ | 17.75  |  |  | 281,245 | 
|March 31, 2006     |  | $            | 18.50 |     | $ | 16.26  |  |  | 100,211 | 

As of March 15, 2008, there
were approximately 290 holders of record of the common stock of the Company.

DIVIDENDS

The Companys primary source
of cash is dividends from the Bank. The Banks ability to pay dividends is
subject to certain regulatory requirements. The California Financial Code
restricts the total dividend payment of any bank in any calendar year to the
lesser of (1) the banks retained earnings or (2) the banks net income for its
last three fiscal years, less distributions made to shareholders during the
same three-year period. As of December 31, 2007, the Bank had $15.2 million in
retained earnings available for dividends to shareholders. In addition, the
Companys ability to pay dividends is subject to certain covenants contained in
the indentures related to the trust preferred securities issued by the Trusts.

The
power of the board of directors of an insured depository institution to declare
a cash dividend or other distribution with respect to capital is subject to
statutory and regulatory restrictions which limit the amount available for such
distribution depending upon the earnings, financial condition and cash needs of
the institution, as well as general business conditions.

54

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Stock Performance Graph

The following chart, compare
the yearly percentage changes in cumulative shareholder return on our common
stock during the five fiscal years ended December 31, 2007., with (i) the Total
Return Index for the Nasdaq Stock Market (U.S. Companies) (ii) the Standard and
Poors 500 and (iii) the Total Return Index for the Nasdaq Bank Stocks, as
reported by the Center for Research in Securities Prices. The comparison
assumes $100.00 was invested on December 31, 2002, in our common stock and the
comparison indices, and assumes the reinvestment of all cash dividends prior to
any tax effect and retention of all stock dividends. Price information from
December 31, 2002 to December 31, 2007, was obtained by using Nasdaq closing
prices as of the last trading day of each year.

(LINE GRAPH)

|                      |  |               |        |            |   |            |  |            |        |            |   |            |  |   |        |  |   |        | 
|--------------------- |  | ------------- | ------ | ---------- | - | ---------- |  | ---------- | ------ | ---------- | - | ---------- |  | - | ------ |  | - | ------ | 
|                      |  | Period Ending |       
|                      |  |               |       
|Index                 |  | 12/31/2002    |        | 12/31/2003 |   | 12/31/2004 |  | 12/31/2005 |        | 12/31/2006 |   | 12/31/2007 | 
|                      |  |               |        |            |   |            |  |            |        |            |   |            | 
|Pacific State Bancorp |  | $             | 100.00 |            | $ | 201.75     |  | $          | 512.50 |            | $ | 462.50     |  | $ | 543.50 |  | $ | 314.25 | 
|Nasdaq Bank Stocks    |  | $             | 100.00 |            | $ | 129.93     |  | $          | 144.21 |            | $ | 137.97     |  | $ | 153.15 |  | $ | 119.35 | 
|Nasdaq U.S.           |  | $             | 100.00 |            | $ | 150.01     |  | $          | 162.89 |            | $ | 165.13     |  | $ | 180.85 |  | $ | 198.60 | 
|S&P 500               |  | $             | 100.00 |            | $ | 126.38     |  | $          | 137.75 |            | $ | 141.88     |  | $ | 161.20 |  | $ | 166.89 | 

55

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Company and Bank Officers

Steven A.
Rosso 
President & Chief Executive Officer

Gary A.
Stewart 
Executive Vice President & Chief Credit Officer

JoAnne Roberts

Senior Vice President & Chief Financial Officer

Bank Officers

Laura Bunch 
Senior Vice President 
Regional Manager- March Lane
Stockton Main/Tracy/Hayward

Linda Ogata 
Senior Vice President & Manager 
Lodi

Rick Simas 
Senior Vice President 
Regional Manager 
Lodi/Modesto/Angels 
Camp/Arnold/Groveland

Ron Aschwanden

Senior Vice President 
Calaveras County

Marie Verza 
Senior Vice President 
Manager - March Lane

Alan Lozito 
Senior Vice President Branch 
Manager Hayward

Sylvia Hanania

Vice President & Senior Operations Officer

Barbara
Dennison 
Vice President 
Manager  Note Department

Rita Stolp 
Vice President 
Loan Officer  March Lane

Justin Garner 
Vice President - Controller

James Murphy 
Vice President 
Commercial Loan Officer -Hayward

Venus
Colombini 
Vice President 
Manager-Groveland

Patrick Coon 
Vice President 
Manager - Main

Glenn Scott 
Vice President & MIS Director

Stephen Benton

Vice President 
Commercial Loan Officer - Modesto

Lana Littell 
Assistant Vice President 
Credit Analyst

Shelly Urbanek

Assistant Vice President- Lending Services 
Officer-Tracy

Jamie Vroege 
Assistant Vice President-Operations Officer  
March Lane

Maureen
Enright 
Assistant Vice President-Loan Support Specialist

Laurence Held 
Assistant Vice President 
Business Development Officer

John Lozano 
Assistant Vice President 
Loan Officer  Tracy

Jennifer Higby

Assistant Vice President 
Business Development Officer 
Modesto

Jeffrey Dove 
Loan Officer  Angels Camp

Jean Turpin 
Branch Manager-Arnold

Marie
Trigueiro 
Personal Banking Officer  Angles Camp

Samuel Flores 
Operations Officer  Hayward

56

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Michelle
Hendrix 
Operations Officer - Groveland

Rosibel Rivera

Operations Officer  Modesto

Larry
Hernandez 
Operations Officer  Tracy

Touch Keo
(Deborah) 
Business Development Officer

Lori Menchaca 
Operations Officer  Arnold

Traci Barnett 
Operations Officer  Lodi

Susan Winans 
Operations Officer  Angels Camp

Joanne Ford 
Administration Officer

Erick Lacy 
Commercial Loan Officer  Lodi

Phillip Harris

Financial Services Representative 
Modesto

Stock Market MakersFirst Security Van Casper 
San Francisco, CA 
Stephen L. Eddy 
800-652-1747 ext. 727

Howe Barnes
Investments, Inc. 
Michael S. Hedrei 
555 Market Street 
18th floor 
San Francisco, California 94105 
800-800-4693 mhedrei@howebarnes.com

Keefe,
Bruyette & Woods 
Robert Sprotte 
787 Seventh Ave, 4th Floor 
New York, NY 10019 
212-887-8960 rsprotte@kbw.com

Monroe
Securities 
Russel J. Feltes 
343 W. Erie Street, Suite 410 
Chicago, IL 60610 
800-766-5560 rfeltes@monroesecurities.net

Seidler &
Company 
Troy Norlander 
P.O. Box 1688 
42605 Moonridge Road 
Big Bear lake, CA 92315 
800-288-2811 tnorlander@seidlercos.com

Sandler
Oneill Partners, L.P. 
Chris Munch 
919 3rd Avenue 6th Floor 
New York, New York 10022 
212-466-8025 cmunch@sandleroniell.com

Wedbush Morgan
Securities 
4949 SW Meadows Road, Suite 100 
Lake Oswego, OR 97035 
Contact: Lisa Gallo 
1-866-491-7828 
lisa.gallo@wedbush.com www.wedbush.com

McAdams Wright
Ragen 
Joey Warmenhoven 
1211 S.W. Fifth Avenue, Suite 1400 
Portland, OR 97204 
503-422-4044 www.mwrinc.com

Wunderlich
Securities 
Mike Sammon 
1-800-388-3851 
Senior Vice President 
200 W. Madison St. Suite 2950 
Chicago, IL 60606.

FIG PartnersTim Coffee 
1175 Peachtree Street NE, Suite 2250 
Atlanta, Georgia 30361 
tcoffee@figpartners.com

Legal CounselShapiro Buchman Provine &Patton LLP 
John W. Carr 
1333 N. California Blvd., Suite 350 
Walnut Creek, CA 94596

Independent Registered Public Accounting FirmPerry-Smith LLP 
400 Capitol Mall, Suite 1200 
Sacramento, CA 95814

Transfer AgentMellon Investor Services LLC 
85 Challenger Rd 
Ridgefield, Park, NJ 07660

57

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Equity Research AnalystTim OBrien 
Sandler ONeill + Partners. L.P. 
455 Market Street, Ste 2070 
San Francisco, CA 94105
415-978-5033 tobrien@sandleroneill.com

Don
Worthington 
Howe Barnes Hoefer & Arnett 
555 Market Street 
18th floor 
San Francisco, California 94105 
415-538-5733 
dworthington@howebarnes.com

Customer Service877-841-0110

TeleWave Banking877-487-2265Web Addresswww.pacificstatebank.com

Trading SymbolPSBC

Corporate Office1899 West March Lane 
Stockton, CA 95207 
209-870-3214 
Mailing address: 
PO BOX 1649 
Stockton, CA 95201

Shareholder RelationsThe Company has adopted a Code of Ethics as
defined in Item 406 of Regulation S-K that applies to its principal executive
and financial officers and the persons performing similar functions. In
addition, the Company files an Annual Report on Form 10-K with the Securities
and Exchange Commission and Annual Report on Form FR Y-6 with the Federal
Reserve Board. Copies of the Code of Ethics, and latest Annual Report on Form
10-K and Form FR Y-6 are available upon request. Requests for such information
should be directed to: 
JoAnne Roberts 
Senior Vice President/Chief Financial Officer 
Pacific State Bank 
P. O. Box 1649 
Stockton, CA 95201-1649

Member FDIC

(LOGO)

58

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Board Of Directors

Harold Hand,
M.D., Inc 
Chairman of the Board 
Zeiter Eye Medical Group

Steven A.
Rosso 
President & Chief Executive Officer 
Pacific State Bancorp & Pacific State Bank

Gary A.
Stewart 
Executive Vice President & Chief Credit Officer 
Pacific State Bancorp & Pacific State Bank

Michael L.
Dalton, C.P.A., Inc 
Attentive Investment Managers, Inc

Maxwell M.
Freeman 
Freeman, DAuito, Pierce, Gurev, Keeling & Wolf 
A Professional Law CorporationPatricia A.
Hatton, M.D., Inc

Steven J.
Kikuchi 
Landscape Architect

Yoshikazu
Mataga, 
Owner, Mataga Buick Pontiac & GMC 
Mataga Cadillac Tracy Pontiac Cadillac & GMC

Russell Munson

Owner, Wine & Roses Hotel Restaurant & Spa

Kathleen M.
Verner* 
Vice President 
Verner Construction

---